Making defensive preparations

Market Development: The volatility and down drafts in the market continued in April, with the S&P down 8.74%, Europe declining 5.87% and Japan falling 9.59%. The war in Ukraine and expected interest rate increases by the Federal Reserve; combined with a balance sheet reduction is leading investors to reconsider the outlook for equities.

The 10 year US Treasury yield continued to increase rapidly (up 60 bps to 2.93% in the month) meaning that valuations of long duration assets must come down. It is clear that the Central Banks are behind the curve given that inflation rates are running in the high single digits.

Inflationary expectations are changing – initially driven by personal consumption demand during the COVID period, and now more structurally due to energy prices and supply side constraints.

Market Outlook

While all eyes are focused on the actions of the Federal Reserve this week (50 bps increase in rates confirmed), it is now clear that growth expectations in the developed world must come down. The energy cost to Europe for the war must mean that personal discretionary expenditure will fall, which can only result in an economic recession (certainly in real terms if not nominal). Indeed, recent news flow indicates that the European economy does not seem to be growing anymore.

In the United States, news flow from the Technology sector was mixed, as those companies which benefitted from the COVID boom (Amazon, Google, Netflix) are now seeing a slowdown as people spend their money elsewhere. This said, references to slow down across a range of sectors are now appearing as the effects of the war unfold.

The risk exists that Central Banks around the world will tighten interest rates too much in their battle with inflation – difficult for consumers and companies to sustain, given the high levels of debt within the system. We must prepare for a recession in the not so distant future, and further equity market volatility which will go with it – it would seem that the bear market has begun.

Fund Performance

The Strategic Global Quality Fund outperformed the benchmark by 3.06% in April and 2.40% year to date. Most of the alpha generation came from the allocation affect – the overweight to Consumer Staples (25.0% versus 7.4%) was the biggest driver contributing 1.65%; followed by the underweight position in the Technology sector (11% versus 22%) contributing 0.52%; and the overweight to the Energy sector (11.2% versus 4.5%) giving 0.46%.

Individual Stocks

At the stock level, there was not really any stand out movers – on the positive side only two names are worth mentioning, McDonald’s (35 bps) and Fidelity (31 bps). McDonald’s continues to execute well and is a beneficiary of the harsher economic environment as people trade down in their consumption patterns. Fidelity did not move much during the month and outperformed a falling market as a result.

On the downside, Paypal performed poorly (-37bps) as their results disappointed somewhat, while Charles Schwab (-37 bps) declined as people came to realise that the company may not benefit from rising interest rates as expected.

As always, we invite investors and prospective investors, to get in touch should you wish to discuss the positions held in the portfolio. Please do not hesitate to contact us for further 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 05/05/2022 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.