Portfolios have been moving steadily upward now since mid-October last year with gains of 6-8% which are bringing them back to the levels they were at the start of 2021. Still down from the end of 2021 highs but roughly halving the worst of the losses we saw in October last year.
A powerful reminder as to why we stay fully invested, 7% in 4 months, very easy to miss.
October appears for now to have been peak angst. The base interest rate moves in the US and UK this week were both well telegraphed and were lower than were forecast in the summer last year. There are signs that inflation is falling and a sense that any recessions might not be as deep and last as long as was thought. In fact, longer duration yields on both UK Gilts and US Treasuries have been falling this week.
The inverted yield curve in the UK, where 1 year rates are higher than 3-10 year rates, suggests that the market anticipates base rates to fall within the next 24 months from their new level of 4%.
This all bodes nicely for our fixed income funds which are forecast to earn 12-16% in income in the next 24 months, and if base rates do fall, can be expected to deliver some capital gains on top.
Equity markets in the last couple of weeks have been dominated by the earnings releases of the now “not so big cap” US tech stocks with Microsoft, Amazon, Meta (Facebook), Google and Apple all reporting their earnings from the last quarter of 2022.
So far so good would be my view. There is a clear indication that trading conditions are tougher and that revenue growth and profit margins will be harder to maintain. But they suggest that in the main the downward price adjustments of 2022 were entirely justified and current prices look more realistic.
Microsoft, whose shares fell in the immediate aftermath of their earnings release on the 25th January, has now risen around 8% since then. Google, Apple and Amazon are all set to open around 4% down today after strong gains earlier in the week. Only Meta bucked the trend jumping 25% after their announcement suggesting the sell-off in their shares had been over-done.
Before we get too carried away, we need to remember percentage gains in recovery need to be much bigger to restore value after steep falls. Yes, the less mighty Tesla’s shares are up a whopping 75% since the start of 2023, but the share price will need to double in value from here, another 100% gain, to get investors back to their end of 2021 values before the 70% drop in 2022. According to Yahoo Finance, the company valuation is already back to an eye watering 50X price earnings ratio. To double in value again from here, Tesla will need to double its profits in the fiercely competitive electric car market and maintain an earnings outlook to support twice the valuation of the average S&P 500 stock now valued at c19x earnings. What could go wrong?
Microsoft is similarly expensive but less so now at c29 X earnings, American Express a good general indicator is at 18 X earnings. If we look closer to home the much unloved FTSE 100 index of companies, now worth roughly the same in total as Apple, is valued at 14 X average earnings.
So, will this rally in equities last?
Who to Ask?
Our attention in the office this week was distracted by the artificial intelligence (AI) search engine ChatGPT. As you do at 5pm on a Monday we were debating ways to predict the likely yield on 20 year gilts in 15 years’ time. The chartered financial analysts rushed for their text books, Neil Croxford, our COO, quietly tapped on his computer and gave three very precise, totally correct and well explained answers, in less than 30 seconds. Could he explain the first answer in a bit more detail, clackety clack, yes he could!
This took me back to a very entertaining conversation over lunch with two of our clients from the week before. According to one; Oxford and Cambridge are now holding interviews for places on Zoom with prospective foreign undergraduates, it is much greener and avoids students flying around the world, makes sense. However, in China it’s now possible to buy an Avatar that looks like you, speaks like you and contains all the knowledge of a graduate in your chosen course! They have all the answers and will sit the interview!
ChatGPT is incredible. If you have not seen it in action, I highly recommend checking it out. Its propensity to revolutionise the world is beyond thinking. The application of AI in education, problem solving and increasing the capability of robotic tools is immense. As a search engine alone it has Alphabet’s Google search engine worried and rightly so. Tap into Google how to make money with ChatGPT and new businesses are being created using it. OpenAI who owns, it is predicting, $1billion of revenues from it in 2024. Who is the biggest investor in OpenAI and AI generally? Microsoft.
So I asked Neil about this rally yesterday. Could he check what ChatGPT thinks? His reply…” right now it only knows up to 2021!”
The Federal Reserve raised rates by 25 basis points as widely expected with Powell confirming to the market for the first time that the economy’s disinflationary process was underway causing a sharp rally in markets. Powell however emphasised that future Federal Reserve actions will be dependent on the labour market. Although there is anecdotal evidence of job losses, especially employees of big tech, the labour market remains strong.
Both consensus and markets are pricing in rate cuts later in the year which would be beneficial for our fixed income holdings in the short term (especially managers investing in longer duration bonds) but reduce future yield opportunities which conversely would be a negative as far as we are concerned. Furthermore TS Lombard, our macro strategy advisers, believe that the rate cuts will be much sharper than what both the consensus and the market is currently pricing in. In this scenario of yield compression, we would review our overweight fixed income position and look elsewhere for returns.
As James mentions in his piece above, despite rally in markets (which are seemingly looking ahead to the end of the story) we are not getting carried away and will remain cautious until the full effect of rate hikes on global economies becomes clear keeping a close eye on company earnings throughout the first half of 2023.
Our thoughts regarding portfolio construction remain relatively unchanged since the start of the year with the view that fixed income still offers better value than Equities at this juncture, especially if consensus is wrong and the macro picture deteriorates. We are happy to wait and see receiving a yield on our portfolio of Credit managers of between five and eight percent with the macro headwinds of 2022, resulting in the worst ever year for corporate bonds, unlikely to reappear to the same extent.
Whilst the market is rerating upwards (increased market valuations relative to earnings) we will remain focused on fundamentals of the funds that we hold for you, ensuring the portfolio is producing an appropriate level of income and in the form of dividends and coupon interest whilst being laser focused on what our managers are paying for these income streams with the age of free money seemingly in the rear-view mirror.
One area which has been a particular tailwind for portfolios during this market rally has been in Asia and Emerging markets with the catalyst of China reopening catching the market off guard. Despite underperformance last year, with the strong dollar a major headwind, we have been rewarded for sticking with our allocation, with our experienced managers in both Asia and Emerging markets taking advantage of conditions to pick up companies at lower valuations. Similar to the story in the fourth quarter of last year and the outperformance of UK asset returns after a disastrous Q3, it shows the danger of selling on poor short-term performance without understanding the underlying drivers of these returns.
As a reminder, we will only sell managers for one of the following reasons:
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- Team: Core talent leaving the firm not limited to the fund manager
- Capacity: Strategy is too successful attracting excess assets which limits fund managers ability to maintain investment process and replicate performance
- Liquidity: Liquidity profile deteriorates; we need to be certain of our ability to recoup your money in a timely fashion and without moving the market unduly
- Investment Process: Straying from the Investment Process and Philosophy originally outlined to us
- Fundamentals: Strategy fundamentals relative to valuations no longer appealing
- ESG: Evidence that Environmental, Social and Governance risks and opportunities are being ignored
- Performance: Stock mistakes or poor overall portfolio construction rather than a simple decrease in asset prices
- Operational: Regulatory breaches or lack of faith in a fund’s operational and risk systems
- Asset Allocation: The changing of Tideway’s Asset Allocation views with better opportunities available elsewhere
Sector Performance:
Fund Performance versus Benchmarks:
Even with valuations off their lows we anticipate Emerging markets to continue being an area of interest for us in 2023: Although it is difficult to generalise across the diverse regions on offer, we believe Emerging markets collectively offer cheaper valuations relative to developed markets (with local currencies also cheapening) and with profitability, free cash flow and dividends yields all moving higher. Furthermore, emerging markets remain ahead of the curve having raised rates prior to their developed market counterparts with further tailwinds due to the potential for a weakening USD (especially if the Federal reserve cuts rates more than consensus and TS Lombard’s current thesis comes to fruition). As a result, we remain underweight US Equities with other overweight positions in both Europe and UK.
As ever, we are checking in with managers to get their latest thoughts on markets as well as ensuring their strategies are not deviating from their stated investment process. In January we met with investment representatives from Artemis, Fidelity, Royal London, Sanlam (Hybrid Capital and Credit) and Schroders. In February we are scheduled to meet with Dundas Global Investors (Heriot Global), Blackrock, Unicorn Asset Management, Sanlam (Multi-strategy fund). Should anyone like to receive additional analysis on any of our fund selections then please get in contact with your Wealth Manager.
- The content of this document is for information purposes only and should not be construed as financial advice
- Please be aware that the value of investments, and the income you may receive from them, cannot be guaranteed and may fall as well as rise
- We always recommend that you seek professional regulated financial advice before investing