PERFORMANCE UPDATE
A very strong quarter across all risk levels.
Strong performance has been underpinned by strong manager alpha (value add) across many sub-sectors, with both equities sectors and alternatives particular standouts.
Alternatives have performed particularly well since the sleeve redesign in December 2023. All strategies in this sleeve have contributed to performance, including Colchester Emerging Market Bond Fund (+3.9%), VanEck Short Term US Treasury Bills (+3.4%), Aspect Futures (+10%) and the Perpetual Pure Equity Alpha fund (+6.4%). The Alternative assets sleeve is designed to have no dependency on the direction of equity markets.
Key questions we will be looking to answer this quarter:
- What are the drivers of this equity market rally, and can it continue?
- Are we done with tech and quality growth?
FISCAL VS MONETARY POLICY
2024 is set as a tug-of-war between politicians seeking re-election and central bankers looking to lower inflation.
The disinflation narrative remains intact, but perhaps a little slower than Jay Powell at the Fed or Michele Bullock at the RBA would like. This is increasing their anxiety, with the spectre of the 1970s looming large.
On the other hand, a cost-of-living crisis only makes an electorate hungry for help. Politicians who happily dispense fiscal assistance are rewarded with election victories. Both right and left of the political spectrum are embracing, either directly or indirectly, fiscally stimulative policies.
In the US, the inflation reduction act authorises a colossal amount of spending on energy infrastructure. In Australia, stage 3 tax changes will provide a significant boost to household budgets, driving after-tax wages up by around 3%.
Who is likely to win the tug of war?
There is no doubt that government spending is blunting the impact of monetary policy. And in an election year, this fiscal stimulus is likely to prevent the full impact of steep rate rises on the real economy.
Markets are coming to terms with this reality. Cutting rates is going to be difficult for central banks when economic growth and spending is boosted by government policy.
Duration and longer rate sensitive investments still stand to struggle in an environment where growth remains strong, with the US a particular stand out in this regard.
VALUATIONS AND EARNINGS
Valuations remain stretched in many global equity markets, but particularly the US.
This makes markets inherently fragile to any dip in fiscal support, and the key reason we are not willing to be completely overweight equities now.
In all regions bar Emerging, returns have been driven by a re-rating as opposed to earnings upgrades.
Stripping earnings further unveils whether markets are driven by buoyant operating conditions or by issuing/buying back stock. It paints a miserable picture of Europe and UK, and quite a buoyant Emerging markets outlook. Of great interest is Japan, where conditions are buoyant, in addition to regulations favouring buy backs and shareholder returns.
WHAT’S DRIVING THE US MARKET?
Earnings in large US technology stocks (the so-called ‘Magnificat Seven’ of Apple, Microsoft, Nvidia, Tesla, Meta, Alphabet and Amazon) have been strongly revised upwards by the global investment banks over the past three months. This promises to be a continued tail wind for these names: we will look to review our position in QUAL or QHAL (MSCI World ex Australia Quality Exchange Traded Funds) once we see these earnings upgrades run out of steam.
Outside of the big US tech names, earnings are far less convincing.
AUSTRALIAN EQUITIES REPORTING SEASON
February 2024 was an indifferent reporting season overall, with the average earnings downgrade running at -0.5%. There was great disparity within sectors, and no clear read across the board. For instance, we saw Woolworths and Coles/Wesfarmers pointing to very different experiences, though typically subject to the same macro forces. We are still grappling with reconciling Big W suffering a torrid half while Kmart seemingly impregnable.
Cost management often seemed to separate winners from losers. It is an acute challenge when wages are growing at growing at over 4%, and one not faced by many management teams in recent times. Strong cost management was evident at Wesfarmers, Treasury Wines, Amcor, and is an important positive indicator on company culture.
While retailers performed strongly, they remain on peak multiples facing a weakening economy in 2024. We remain wary of adding exposure at this point, given downside risks, though acknowledge fiscal support (for instance stage three tax cuts) will remain supportive.
In terms of stocks here are some clear positive standouts:
Cochlear (COH): circa-15% unit growth, 20%+ revenue growth. Strong tailwinds for this stock. Risk factors include CMV vaccine, which is heading into phase 3 later this year, though we would likely see this as an opportunity to accumulate more stock.
WiseTech (WTC): 20%+ revenue growth ahead of expectations. Altium’s takeover drove up all tech names in February.
Treasury Wines (TWE): navigated potential banana skin as global wine consumption drops, however cost discipline and some helpful commentary around DAOU acquisition helped propel the stock.
HUB24 (HUB): strong revenue growth continuing to propel the stock forward.
The market took these results a little poorly:
NIB Holdings (NHF): nothing to note in the result, with earnings in line, though stock was notably down 10% over February.
TPG Telecom (TPG): balance sheet risks are overwhelming what was a reasonable operational result, with mobile subscription performing well. Balance sheet repair via asset sales, or refinancing, will be particularly well received when it occurs.
Real Estate, Infrastructure, Energy and Banks were noticeable laggards, while IT, Insurance and Financials were upgraded. EPS upgrades by sector are shown in the following chart.
We believe the environment remains conducive to quality growth investing:
- High financial leverage weighing down worsening debt serviceability – strong balance sheets.
- Economic growth domestically is slowing – high quality and stable non-cyclical earnings.
- Population growth is supported by immigration – structural growth in the economy.
PORTFOLIO CHANGES
We are currently happy with the existing portfolio positioning, being overweight technology and quality growth equities exposure, and underweight rate sensitive sectors such as Real Estate Trusts and Infrastructure, due to our view on rates and inflation expressed above. We are also happy being underweight bond duration exposure, and our corresponding holdings in alternatives, which have performed well.
Hence for this rebalance, we would rather keep the turnover budget up our sleeve, and only propose minor tweaks, mostly to direct stocks. Specifically, across all models, we are taking some profits on Goodman Group and HUB24:
Goodman Group (GMG): will be entering the FTSE REIT index, which will result in some underperformance on the effective date (all the passive buying pressure will be in advance of that date).
HUB24 (HUB): has had a great twelve months but is just being re-sized for risk management reasons.
On our Moderately Conservative and Defensive portfolios, we are also trimming International Equities as it nears the top of our asset allocation range.
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.
