June 2022 Review

By Paul Sedgwick Portfolio Advisor

Dear Partner

As the first half of the year draws to a close there have been few areas for savers to hide so far. Cash has been eroded by inflation, equities and bonds have reacted to tighter monetary policies. Central bankers remain hawkish as US interest rates are now forecast to rise to 4%, towards the end of the year, and the Bank of England to raise interest rates to 3%. Metal prices have fallen on growth concerns and the one asset that is expected to perform, gold, during periods of inflation, has done little. The US dollar has reached multi year highs as investors look for safety assets.

 

The correlation between now and the early 1980’s is interesting, as the Federal Reserve, then chaired by Paul Volcker, came in and raised interest rates aggressively to combat inflation, rather as Jerome Powell has been forced to do in 2022. As was the case in the early 80’s the inflation picture was further complicated by the effect the Iran-Iraq war had on oil prices. As is the case now asset classes across the board fell, indexes, so far, by a similar degree.

 

Although, on the face of it the US economy remains robust as unemployment levels remain low and manufacturing PMIs indicate an expanding base, the Citi economic surprise index has been consistently falling in recent months, as economic data has failed to meet analyst forecasts. The Bank of England are in a difficult position as the economy falters, but inflation remains a problem. Last month they took criticism for not raising rates more aggressively to combat rising prices. The weakening pound will compound any inflationary forces.

 

Total Return Balanced and Total Return Equity Portfolio Review

 

Global stocks have fallen around 6% this month which has had an impact on our portfolio. US stocks fell by around 12% in the quarter, and are, by definition, entering a bear market having fallen over 20% this year.

 

We have been underweight technology and having seen the correction in the sector feel it is time to add some exposure for the longer term. With a dividend yield of 3% and a global reach in the semiconductor industry, cash on the balance sheet, and a valuation in line with US equities this makes for an attractive entry point. Although there may some short -term headwinds. For this reason, we have entered the position in a moderate way. Texas Instruments reports second quarter earnings later this month.

 

Top performing positions last month were Colgate-Palmolive, Reckitt Benckiser and British American Tobacco, all benefitting from the defensive nature of their business. The new addition of Estee Lauder in our portfolio outperformed the market in June. Our portfolio is very much geared to defensive nondiscretionary companies and this defensive positioning has benefitted us to a certain degree this year. THG, PayPal and IMI our underperformers in June.

 

THG is a very small position in the portfolio and was negatively affected are a potential bidder confirmed that it was no longer pursuing an acquisition of the company. Softbank are also not likely to exercise their option to acquire part of the business given the current market capitalisation of the group is £1bn and the CEO has recently sold £2.5m of shares. Nevertheless, the underlying business is performing well and all divisions are growing strongly. We believe there is much more value from the group in the coming years, as do investment analysts, and we continue to hold the small position in our portfolio. The newly appointed chairman, Charles Allen, has yet to have the time to make his mark.

 

PayPal continues to be affected alongside the technology sector falling valuations. The group reported that its customers are likely to be impacted by rising interest rates and reducing their discretionary spending using the platform, this resulted in a reduction in this year’s forecasts, albeit with a 10% revenue growth target. Almost all investment analysts maintain a Buy recommendation on the stock, with the average share price target materially higher than the current level.

 

IMI reported strong results in May with a Q1 9% increase in revenue and has made some small add-on strategic acquisitions. The stock reacted negatively investment analysts lowered their estimates for full year earnings, partly due to a 4% decline from exiting Russian operations. The company remains well positioned for carbon reduction demand in water systems in the built environment, as well as components in precision engineering such as ventilators and for life sciences, and critical engineering for the energy sector. IMI remains a quality company in a growth area that could well attract suiters.

 

Market Overview

 

Looking to the second half of the year, there are some signs inflation could be peaking in the US in the coming months. June’s manufacturing PMI report underlined this view. Shipping rates are falling, metal prices have fallen sharply in the first half of the year and recently even some soft commodity prices have corrected. Oil too has fallen around 10% from its highs. Economic data continues to create volatility, last week the unexpected drop in consumer inflation expectations sparked something of a rally only for a weak consumer report at the start of the week to cause a setback.

 

The pattern over the summer may continue to be a more volatile time as many portfolio managers are on holiday and liquidity remains thin. The upcoming earnings season will more than likely be crucial to the summer months as well. Earnings expectations have been lowered however corporate earnings are still expected to grow year on year.

 

At the start of the month we reported the negative sentiment for most asset classes, this remains the case as macro strategists remain cautious for both bonds and equities. Unlike the start of the year the view is becoming more consensual.

 

 

There may be reasons to be slightly more optimistic for the second half of the year. US stocks have corrected largely in response to rising interest rates and now look better value. The equity risk premium, based where longer dated bond yields currently stand is now closer to historic averages. That does assume companies can meet their upcoming earnings expectations. As we noted inflationary pressures appear to be easing, particularly US ones and this may in turn encourage the Fed to turn more dovish as the year progresses. The other point worth noting is corporate, personal and banking balance sheets are generally much stronger than they historically at this time. Although there is much talk of a likely economic recession in the US, stocks tend to get there before analysts.

 

The balance between the performance of the US dollar, bond yields along with corporate earnings, economic indicators and the outlook for Federal Reserve policy will continue to dominate investor sentiment. I heard a wonderful phrase the other day; “Bear markets are when you make the money, you just don’t realise it at the time.

 

Yours sincerely

 

Cube Capital