An optimism and corrections rally?

Market Development: January saw a strong start to the year for risk assets as the US Dollar, VIX and inflation expectations declined. Optimism centred around: normalising energy prices; China re-opening; and a narrative of peaking interest rates, and was compounded by central bank officials being less hawkish than expected.

The official data was seen as supportive of this, and the initial bearish positioning of the markets allowed for major rallies in equities, bonds, credit, EM, cryptocurrencies and most commodities. Meanwhile, housing starts, exports, construction and other leading indicators showed a continued deterioration in economic conditions, and forecasts for monetary policy went “higher for longer” around most of the western world.

The BoJ is set to welcome a new governor, with internal candidate Kazuo Ueda presumed to take the chair. In January, the MSCI World index returned 7.08%, the S&P 6.18% and the NASDAQ 10.68%. Meanwhile, the MSCI Europe was up 6.79%, the Nikkei 4.73% and the Hang Seng 10.42%.

Market Outlook

In our view, the equity market environment remains complicated, due to the fact that the central banks in the United States and Europe are intent on raising interest rates further; and keeping them high for longer. This is then combined with QT and the US Treasury Reserves now being flat rather than declining. This tightening of monetary conditions is happening at historically high rates and we have not yet seen the full effects of this on the economy.

Our outlook remains the same. The corrections in the Tech sector, SPACs, cryptocurrencies and Real Estate markets around the world have seen some reprieve of late, but in our view, this is a matter of timing. During the Q1 earnings season, corporates have been guided to revenues holding up, whilst earnings were down and future earnings expectations continue to fall.

We expect the market’s current willingness to look through will eventually fade as the data starts to confirm that the recession started some time ago, if not before. The central banks will then be forced to change course and we will begin to see how much damage has been caused to the real economy and the implications for earnings. Thus, we remain cautious in our outlook as we are still in a bear market for the time being.

Fund Performance

The Strategic Global Quality Fund returned 4.78% in January. Alpha was held back by the allocation effect (-2.59%), with the selection and currency effects both positive at 0.17% and 0.27%, respectively.

At the sector level, the Fund benefitted from being overweight in Health Care (18.12% versus 14.06% for the benchmark) and Materials (8.91% versus 4.61%), which added 0.63% and 0.46% to return respectively. That said, underweights in Consumer Discretionary (2.25% versus 10.30%) and Financials (3.40% versus 14.48%), outweighed these contributions, costing 1.36% and 1.22% respectively.

Individual Stocks

As mentioned, stock selection in aggregate was a positive contributor to performance in January. The top three performers were Rheinmetall (+0.38%), IQVIA (+0.26%) and Amadeus (+0.25%). The laggards were AIG (-0.24%), McDonald’s (-0.24%) and Colgate (-0.12%).

Rheinmetall is benefitting from a renewed focus on defence spending in Europe, driven by the war in Ukraine. In January, the German government gave the go-ahead for Rheinmetall and allies to supply leopard tanks to Ukraine. They also won contracts relating to Electromobility, Air Defence and the US Army’s Tactical Truck Program, among others, such that the order backlog is now approaching €30bn.

At the end of the month, they also issued a convertible bond to fund the acquisition of Expal Systems, which will bring increased capacity and a wider product portfolio to Rheinmetall. Finally, the company is also rumoured to be in talks with Lockheed Martin to begin manufacturing HIMARS in Germany.

IQVIA rallied as its peer, ICON, reaffirmed FY2022 guidance at the JPMorgan Healthcare Conference when the market was expecting to see a deterioration in the Q4 numbers. Furthermore, it guided FY2023 earnings to be well ahead of consensus expectations. Later in the month, IQVIA also signed the first life sciences industry collaboration with Alibaba Cloud to allow their customers to better serve their clients and patients in China.

Amadeus saw several upgrades from sell-side analysts at the start of the year and was propelled higher as Ryanair released guidance easing concerns over demand in 2023.

Turning to the detractors, AIG went sideways in January. CFO Shane Fitzsimmons took a medical leave of absence before interim CFO Mark Lyons was fired for violating his confidentiality / non-disclosure obligations.

Mark Lyons was a key figure in the company’s turnaround over the past five years and as such, it is a shame to see him go, but we do not believe it changes the investment case. The shares remain too cheap for a P&C insurer delivering a good return on equity.

McDonald’s made a good start to the year and markets appreciated the revitalised cost focus, but fell back as Q4 margins and guidance for 2023 margins missed estimates. The company said it would take on higher costs to support its franchisees, predominantly in Europe, whilst still managing the balance of higher costs and volumes. McDonald’s remains a high-quality company, and we believe it will generate a lot of value over the years to come.

As for Colgate, the shares underperformed in January as the market turned to favour more beta-driven stocks as recessionary fears eased, compounded by weaker-than-expected gross margins announced in Q1 and unambitious guidance. We feel guidance is low, especially given the pricing power Colgate has shown, and that volumes should return as peers are now also raising prices.

Beyond this, Colgate is too cheap given its defensive nature in inflationary and recessionary conditions, the value in its Hill’s Pet Nutrition business, and an approaching earnings inflection. The acquired Pet Food plants should be supportive as they ramp up. Colgate also has the option to consolidate in the attractive Consumer Health sector. All this is bolstered by a new activist shareholder.

As always, we invite investors and prospects to contact us should they wish to receive any additional information.

Adam Turberville
Director
+44 1481 742380
a.turberville@ericsturdza.com

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The views and statements contained herein are those of  Lofoten Asset Management in their capacity as Investment Adviser to the fund as of 16/02/2023 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.