Market Overview: If one looked only at the chart of the MSCI World Index not knowing anything else, then one could simply conclude that last year was a simple year with a straight-line progression. Of course, life or investing is never that simple.
Investors had to contend with the re-opening of the economies over the summer post lockdowns, then to be confronted with a third wave flare-up of COVID as the winter approached. The continued extra-ordinary injections of liquidity by the Central Banks meant that the US markets had a particularly strong performance, with the S&P 500 up almost 30% during the year. European markets were up around 15%, while the Nikkei was down (in USD terms).
From a historical view, the intervention by the governments and central banks is unprecedented outside war times. We believe this has created a true blow-off bubble in the growth names in the market (Technology in particular). However, signs that all is not well became apparent as the year progressed, with many highly rated stocks falling in absolute terms. The breadth of the market worsened, but the strong performance of the FAANGs meant that the indices did well. We strongly believe that the forecast increases in the US interest rates will spell trouble for the markets during 2022.
We expect 2022 will be a year where the development of the financial markets will not necessarily follow the expected strong economic growth. Forecasts of GDP growth of 4%+ around the developed world are not uncommon given the continued normalisation of the economies as COVID becomes an endemic rather than a pandemic.
However, the high levels of inflation experienced around the world are causing the Central Bank to review its accommodative policies. The Federal Reserve has just confirmed that its QE programme will end in March, as well as signalling several interest rate rises for the current year.
The debate today is to assess whether the investment environment has structurally changed from deflationary to inflationary. In the short term, it is clear that this is good for the sectors which benefit from rising interest rates (Banks and Insurance companies in particular), but not so good for long-duration stocks such as the classic defensives, in particular, the Technology sector, given the high valuations.
Many of the expensive stocks in the market have already been derated in 2021, but expectations are that this process will continue in 2022. Sector rotation to date has been vicious (with historically large moves). If it becomes clear that inflation expectations have to structurally rise, then this rotation will have further to run.
Accordingly, we have already rebalanced the Strategic Global Quality Fund to some extent towards the Financial and Oil sectors. It is our view that the Oil price will remain structurally high due to the recent lack of investment in the sector, combined with the fact that the world will be needing it for the foreseeable future.
Economic growth is expected to be strong this year as the economies normalise, which will be good for the economically sensitive sectors such as Advertising (Alphabet, Facebook, JC Decaux), Banks (we are considering its position), Commodity stocks (Shell), Consumer Discretionary (Kering), Insurance (Swiss Re and Zurich) and IT (SAP).
For some time, we had the view that the United States markets were overvalued from an absolute, as well as a historical point of view, especially in relation to the Technology sector. Accordingly, the Fund has been relatively underweight towards this section of the market and thus also US start-ups, whilst being overweight on a relative basis to the European markets (10-15%).
This geographical underweight to the United States cost approximately 5.7% alpha, whilst the underweight to Japan was a positive contributor of nearly 1%. If we look at the sector attribution, the largest detractors were the overweight allocation to the Consumer Staples sector (-3.2%), the underweight to the IT sector (-1.2%) and the Financial sector (-0.9%).
When examining the stock selection effect, it was broadly positive, adding 2.1%. Among the top performers were Novo Nordisk (1.35%), Siemens Healthineers (0.77%) and JC Decaux (0.59%). Novo Nordisk received approval to start selling its long-awaited anti-obesity drug (Wegovy) with early indications that this is going to become a very large revenue driver for the company – it is possible that the revenue from the obesity side could become more important than the traditional insulin products it sells.
Siemens Healthineers purchased the United States-based Varian to become the world number 1 player in MRI diagnostics, as well as radiation machines – the outlook for this sector is good given the ever-increasing number of people who need cancer treatment. JC Decaux is the world leader in Outdoor Advertising (billboards), and this performed well on the expectation of the reopening of the economies.
Among the bottom performers were Fidelity National Information (-2.08%), JDE Peets (-1.48%) and Unilever (-0.37%). JDE Peets, the world number 2 pursuer of coffee, suffered on dull guidance for the year, combined with expected margin pressure on the back of sharply rising coffee bean prices. Demand for coffee is fairly resilient and we believe the company can manage through this difficult patch.
Fidelity National Information, a provider of bank systems and third-party merchant payment solutions, suffered as the market came to view its technology as old and irrelevant. We believe the demand for its services will remain strong for the foreseeable future and that the stock should rerate over time.
Lastly, Unilever performed poorly given the company is not seen to be growing; combined with fear of a margin reset in relation to price pressures with regards to its input costs.
The Strategic Global Quality Fund (A USD Class) returned +14.20 for the period.
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.
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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 02/02/2022 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.