Inflation enthusiasm

Market Development: In November, the MSCI World Index (total returns in USD) gained 6.95%, the EURO STOXX 50 (net returns in EUR) returned 7.27% whilst the S&P 500 (total return) also ended the month in the green, higher by 5.59%. The Dollar Index (DXY Index) lost 5%, whilst the generic 30Yr Treasury yield decreased from 4.16% to 3.73% and the VIX came down significantly in light of lower risk aversion, from 25.9 to 20.6.

Fund Commentary
20 Dec 2022

Market Development: In November, the MSCI World Index (total returns in USD) gained 6.95%, the EURO STOXX 50 (net returns in EUR) returned 7.27% whilst the S&P 500 (total return) also ended the month in the green, higher by 5.59%. The Dollar Index (DXY Index) lost 5%, whilst the generic 30Yr Treasury yield decreased from 4.16% to 3.73% and the VIX came down significantly in light of lower risk aversion, from 25.9 to 20.6.

November saw a broad rally in all risk asset classes materialise on the back of the US CPI reading showing signs of a second derivative change, i.e. a reduction in the rate of increase: from 8.2% to 7.7% YoY. The Fed increased its policy rate by another 75bps, as expected, but opened the door to a milder tempo going forward…

At the same time, Mr Powell mentioned the possibility of revising its terminal rate to a higher level, showing the Fed’s resolve not to pivot too early. The macroeconomic picture supports the Fed’s ambivalence, as retail sales shot up while industrial production came down.

The mid-term elections did not see a red wave materialise, as many had expected, and instead, will ensure a split parliament with limited ability to pass significant partisan legislation. This likely provides additional visibility from an economic environment standpoint and reduces fiscal stimulus potential going forward.

In markets, the CPI print catalysed a significant risk-on rally across all risk asset classes: heavily shorted stocks bounced the most given short covering pressures, credit spreads compressed adding to a welcome contribution for interest rates coming down for bond investors, and the USD finally gave up some of its strength against other currencies, notably Euros and JPY, as interest rate differentials and haven demand conspired against the USD for the first time this year.

All of this contributes to an effective easing in financial conditions, a positive for investors but likely something that will come under scrutiny at the Fed, given the risk of leaving the inflation fight before a definitive victory.

The demise of FTX and the crash of large swaths of the crypto space have, thankfully, not rippled through the traditional financial markets, but are an additional episode in the great correction of post-COVID excesses – all important, yet painful catalysts towards building a sustainable bottom.

Market Outlook

This past year has been challenging to the traditional 60/40 portfolio, given the repricing of all asset classes on the steepest interest rate hiking cycle in recent history.

While questions remain on the macroeconomic fundamentals for the coming year, the light at the end of the tunnel on the inflation front seems to be in sight, although still blurry and mired in uncertainty. Prospective returns, however, are now improved for our balanced style of management given reinforced risk premia across the spectrum of financial assets, including high-quality credit.

Of course, the Federal Reserve will likely require high levels of certainty before stepping away from the inflation fight, and the terminal interest rate is yet unknown – all of this to say that optimistic caution is still advised. Yet, all in all, a dose of good news now is likely to support a stabilisation of funding markets and corporate activity, leading investors to a more balanced or constructive view.

Portfolio Development

The Sturdza Family Fund‘s NAV increased by +3.33% during the month, reflective of the above-mentioned conducive environment for risk assets overall.

In terms of equity contribution, Intercontinental Exchange led the way (+20bps), followed by Cooper Companies (+19bps), Meta (+19bps), SBM Offshore (+16bps) and SIG (+16bps).

On the detractors’ side, the bottom performers were Medtronic (-16bps), Teleperformance (-13bps), Global Payments (-12bps), FIS (-8bps), and Maravai (-5bps).

While many of these moves emanated from short-term earnings-related news, we highlight Teleperformance’s correction given its idiosyncratic nature: allegations of employee mistreatment at its Columbian office sparked a significant correction in the share price, likely exacerbated by its normally pristine ESG reputation.

We view the company’s response as positive and reassuring: transparently communicating to refute these accusations; launching both an internal and external audit; opening up offices to investor scrutiny; signing a global agreement with UN Global Union; proactively engaging local officials; and launching a share buyback.

With double-digit earnings growth on the cards and a global leading franchise, the resulting valuation of close to 15x 2023 EPS looks attractive to us given what we view as an over-exaggeration given limited evidence and minimal potential economic impact, and we thus have seized the opportunity to increase our position.

During the month of October, we initiated positions in hybrid corporate bonds given the significant spreads on offer, suggesting a mini-dislocation in this niche segment of the fixed-income market, which could offer equity-like returns with quality credit risk characteristics.

The risk rally in November enabled these securities to partially correct this exaggeration, with an overall contribution of 21bps, led by the Firmenich 3.75% (+6bps), Vattenfall 3% (+5bps) and La Poste 3.125% (+5bps).

As mentioned in the past, the name of the game continues to be volatility in risk assets, amid tension between slowing year-on-year inflation readings and the risks of recession in 2023 – a real tug-of-war between the cost of capital and medium-term earnings projections.

In line with our outlook, the Fund remains active, looking for opportunities to upgrade the quality of the portfolio and focus on strong franchises offering growth, reasonable valuations and limited economic exposure, yet seize opportunities to deploy capital at attractive prospective return levels.

As always, we invite investors and prospective investors, to contact us should they wish to understand our views on the current situation and the positions held in the portfolio. Please do not hesitate to contact us for further information.

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


The views and statements contained herein are those of Banque Eric Sturdza SA in their capacity as Investment Advisers to the Fund as of 14/12/2022 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.