DPW portfolios were down slightly in October as global fixed income and the Australian dollar fell. The Australian equities sleeve generated an additional 20 basis points of Alpha over the benchmark, pleasingly our equities sleeve has outperformed its benchmark by 3.2% p.a. over the last three years.
Macro Commentary
In October, markets retreated slightly from their all-time highs as expectations of interest rate cuts across developed markets were pared down. In Australia, the S&P/ASX 200 fell by 1.3% during the month. Within the benchmark, the Financials sector muted the loss, rising by 3.3% during the month. Consumer Staples were the worst performing sector, falling by 7.0% with the main negative contributor being Woolworths Group (WOW) which announced a profit downgrade, citing customers spending a greater share of their cart on discounted low-margin goods.
In the US, the S&P 500 fell by 0.9%, as corporate earnings reports generally met expectations but management’s cautious outlook tempered investor sentiment—especially within the big technology firms. This sector has fuelled much of the S&P 500’s 22% gain this year, largely due to the accelerating adoption of Artificial Intelligence (AI), which has driven significant earnings growth. However, big tech companies are making substantial capital expenditures to upgrade data centre infrastructure to support generative AI workloads.
For instance, Microsoft reported a capital expenditure of $14.9 billion USD in the latest quarter, marking a 50% increase year-on-year. Concerns about high spending and slower revenue growth have led to post-earnings declines for companies like Microsoft and Meta. Nevertheless, we believe these investments will enable big tech firms to expand revenue by enhancing product offerings while also realizing internal cost efficiencies, as generative AI boosts productivity across engineering and operational functions. We maintain a preference for these quality growth companies.
Australia’s labour market remains exceptionally tight, with September data showing the unemployment rate dropping to 4.1% despite a record-high labour force participation rate of 67.2%. While headline inflation appeared to cool, rising only 0.2% quarter-on-quarter, this was largely due to temporary electricity rebates. Core inflation pressures persist, as evidenced by the RBA’s Trimmed Mean inflation measure, which rose by 3.5% year-on-year, well above the RBA’s 2-3% target. This persistence has led traders to largely discount the likelihood of rate cuts in 2025, with swaps indicating a 62% probability of a 0.25% rate cut by November 2025.
In the US, economic data has remained robust. Early October’s labour market report showed the addition of 223,000 jobs in September, surpassing the 140,000-consensus estimate. Inflation also rose slightly more than anticipated, while preliminary Q3 2024 GDP growth was reported at 2.8% year-on-year—just below the 3.0% consensus and Atlanta Fed’s mid-month 3.5% GDP Now estimate. Overall, the data remains positive, with strong economic growth, a labour market nearing pre-pandemic levels, and ongoing disinflation. These indicators likely reinforce the Federal Reserve’s confidence that current rates are not overly restrictive, supporting a cautious approach to any future loosening of monetary policy.
Global bond markets have declined from their mid-September highs, as resilient US economic growth has tempered expectations for the speed and scale of future interest rate cuts. The Vanguard Global Bond ETF, which tracks the Bloomberg Global Aggregate Index, dropped by 2.2% in October, while Australian government bonds saw a slightly steeper decline of 2.7% for the month. We continue to favour Australian fixed income over US fixed income, as Australia faces a higher recession risk due to a faster slowdown in consumer spending and a relatively limited capacity for government borrowing to fund deficits. Given the pronounced inversion of the US yield curve compared to Australia’s flatter curve, we see Australian fixed income as offering better potential for capital appreciation should economic growth slow in Australia and the RBA is forced to expedite rate cuts.
The most likely outcome of the Trump election win is higher US bond yields. If Trump remain committed to substantial spending agendas, this spending could marginally boost earnings for US equities, though higher-for-longer interest rates may negatively impact highly leveraged sectors like property and infrastructure, where we are significantly underweight.
Trump may also bring additional tariffs on Chinese exports to achieve trade surpluses, which could potentially spur inflation but remains less predictable an impact compared to government spending.
October Portfolio Positioning
Our underweight to the Woolworths and Coles in the Consumer Discretionary sector delivered a large chunk of outperformance and our underweight to Banks, in particular, index heavyweight CBA detracted from performance.
Woolworths Group (WOW) released a weak trading update, citing customers who are under significant cost of living pressure opting to purchase more heavily discounted goods during the quarter. This eroded margins in the Australian Food category to below management’s expectations, and the stock sold off as a result. This weakness in consumer staples spending reaffirms our view that the current combination of high rates and high inflation is beginning to slow consumption and erode economic growth in Australia.
During the month we exited our position in WiseTech Group (WTC) after the announcement that Founder and CEO, Richard White would step back and begin a transition to a new CEO over allegations of improper behaviour. White has long been recognized as the key architect behind WiseTech’s product development and strategic direction, and our investment thesis was heavily reliant on his continued involvement. In addition, given his 30% stake in the company and his strong ties with other key investors and executives, it’s reasonable to assume he exerts considerable influence over nearly half of the shareholder base. This could raise concerns about future governance dynamics.
Internationally, a pull-back in expectations of deep cuts to the Federal Reserve Rate in the US caused the US Dollar to surge, benefitting unhedged international assets such as the VanEck 1–3-month US Treasury Bond ETF (TBIL). TBIL rose by 6.03% during the month, while longer duration US assets – where we are significantly underweight – fell.
More recently, we are selling Incitec Pivot (ASX: IPL) as it has hit the top of our valuation. Since we have held the stock, it has sold the Waggaman Ammonia Production Facility in Louisiana to CF Industries Holdings, Inc. (NYSE: CF) for US $1.675 billion. IPL has since delivered a significant capital return to investors totalling $1.4 billion comprising on-market share buybacks and special unfranked dividends.
We are trimming both HUB (ASX:HUB) and Qantas (ASX:QAN) as part of a position sizing/risk management exercise after a stellar run up in their share prices recently.
We are adding to our position in CSL (ASX:CSL) as the stock is trading below our valuation and should be well suited to the current market environment.
CSL is one of the world’s largest global plasma fractionators and an Australian global success story. The plasma-products themselves have proven excellent medical products, with wide application, and deliver therapeutic outcomes difficult to achieve by other means. We note the extraordinary revenue growth that CSL has been able to achieve in plasma markets, which justifies the higher valuation. We note the slowdown in plasma collections worldwide with COVID, but now expect a resurgence as COVID passes. Recent downgrade in 2023 we put down to clearing the decks with new CEO arriving.
We are adding to our position in Xero Limited (ASX:XRO) as Xero is in earnings upgrade mode.
Xero is a leading provider of cloud accounting software for small-to-medium businesses and their accountants across Australia, New Zealand, and the United Kingdom. The Xero platform allows subscribers to perform all their invoicing, inventory management, and payroll for their business online, where the data is available in real-time for both them and their accountants. Xero is in a great position to benefit from the structural shift away from desktop-based accounting software to the cloud and provides a huge productivity gain for businesses adopting the software. The company is now in the process of migrating from expansion phase to profit phase. It also has several industry tailwinds, such as tax changes in the US which will incentivise greater use of Xero. Results continue to highlight subscriber growth beyond market expectations.
In Summary
Looking forward the macro-economic and geopolitical landscape is ever evolving necessitating a prudent and diversified approach to investment. By navigating the prevailing volatility, harnessing the power of diversification, and positioning for evolving trends such as the trajectory of US bonds, we can navigate the challenges and opportunities that lie ahead.
Feel free to call me if you would like to discuss.
Regards,
Greg Davis
Director
Greg Davis Authorised Representative 1245528 and Davis Private Wealth Pty Ltd Corporate Authorised Representative 1299449 are authorised representatives of Sentry Advice Pty Ltd (ABN 77 103 642 888, AFSL 227748).
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