In May the fund declined by 0.9%.
As we come to the end of one of the most aggressive tightening cycles in decades, it’s probably not surprising that markets have become myopically focused on macro factors. For the past few months it seems like there’s only been three topics under debate: Interest rates in the US, the faltering Chinese economy and the economic impact of AI taking-over everything.
We try not to get too absorbed in these topics even though the cornerstone of our process has a clear tilt towards macro factors. Looking at the spread over the cost of capital could even be considered analogous to the approach a fixed-income investor might take, but that’s really where the similarity ends. Primarily this is because on the whole we see the link between macro factors and equity market prices to be pretty unclear and can sometimes interfere with an otherwise attractive bottom-up investment.
Whilst it’s virtually impossible for fixed income assets to buck-the-trend of the interest rate cycle, with equities there’s almost always some corner of a market, or indeed some market in a corner of our universe that can offer long-only investors a positive return. That’s why for anything further than our ‘catch-all’ cost of capital process, we only use macro analysis for context.
As an illustration let’s take our recent experiences in Brazil, where everything tends to be extreme. Over the past few years 10 year local bond rates have surged from 6.5% to 13.5%. In the equity market the MSCI Brazil index recorded a notable high on 4th April 2022 and after a series of mini down-cycles made a recent low on March 23rd with a dollar drop of 35%. Yet during this time within our qualifying dividend-paying universe, 25% of these stocks made a positive return.
Recently the market has started to recover and as of month end this figure has increased to over 50%. Inflation continues to fall (now at 3.9%), the trade balance is at all-time record surplus and although policy rates are still at 13.75% the 10 year bond has tightened to 11.5%. All this triggered a flurry of upgrades of both the market and individual stocks.
Late last year sell-side commentators where quick to move Petrobras to a ‘sell’ post-elections and as the price of oil fell, we however held on to it and now it’s back at an all-time high. Ironically Petrobras is a better investment with oil at $70 than it is at $100. Why? Because it’s now less politically sensitive, truckers can afford the diesel, the government wants the dividends and it’s still generating $8bil in free cash flow every quarter, so they still haven’t changed the dividend policy. We’re not getting the $21bil in dividends that we received in Q3 last year but for the last two quarters they’ve paid $4bil which equates to a 5% yield every three months.
We have a similar situation currently in China. Whilst the obvious self-harm of zero-Covid lockdowns has been removed, there’s still the double whammy of cyclically low demand combined with a Judgement Day for those with excessive borrowing (particularly local government financing vehicles) whilst in a tight revenue environment. The broad top-down picture looks poor and is compounded by plenty of scepticism around the official macro data. However, we now get a broad spectrum of third-party data from which we can gather a much more granular view of the state of play, particularly with the consumer.
Although “property sector woes” get all the headlines and are indeed a huge part of China’s continued weak performance, it’s possibly now more a symptom rather than the cause of the problem. What’s clear in sentiment surveys is that elevated levels of job insecurity, particularly amongst the higher income levels, is having a significant effect on spending habits particularly for real-estate. Very high youth unemployment is well-known but recently there’s also been job losses and even wage cuts amongst the SOEs, particularly in the financial sector.
What we can see is this has driven a heightened propensity to save more (gold and bank issued trust products) and spend on smaller ticket items. This includes entertainment, domestic travel, dining-out and higher-end brands especially in relation to fitness, which has seen a significant boost post-Covid. Basically, they’re wanting to have some fun.
You can see this reflected in our recent allocations towards the likes of Momo (on-line dating), Fufeng (food seasoning), Sasseur (outlet malls) and Sinopec (refining) all of which have been at cyclically low valuations, have strong balance sheets and yields between 6-15%. Some of these could simply be short term spikes in demand but the good news is that hiring trends appear to be bottoming and undoubtably there will be further targeted support measures which should provide a more positive feedback loop.
The essential point is that it can be easy to get sucked-in to both negative and positive big-picture macro hypotheses, but even if you’re correct you still have to get the timing right to make a positive contribution to returns. If we hold what our models are telling us are undervalued stocks, the risk of being early is mitigated by the dividends we’re accumulating.
This is the last factsheet where we have certain regulatory restrictions on what we can include, nevertheless if you’d like to know more about the portfolio or any of the other topics covered in this commentary, please get in touch with our representatives by clicking this link.