July 2022 Review

It is said that stocks take the stairs up and the elevator down. This month they appeared to take the elevator back up, with the best performing month of the year.

By portfolio advisor Paul Sedgwick

Dear Partner

Looking back, this was the best month for equities in 2022, despite continued concerns for the global economy and a Federal Reserve that went through with its commitment to raise interest rates by another 75 basis points. Reflecting on the post-rate announcement press conference, equity and bond markets came to the conclusion that the Federal Reserve may be considering taking its foot off the monetary brake in the coming months, if only modestly.

Across the board, asset prices recovered in July, with the exception of oil falling by around 10% and is now trading below the price it was before the invasion. The threat Russia could further disrupt gas supplies saw prices rise again. The US yield curve inverted in July, as longer dated bond yields fell sharply, in response to weaker economic conditions. The S&P 500’s year-to-date losses shrunk to 13%, as lower yields and hopes that these weakening conditions will encourage central banks to turn a little more dovish reassured investors.

Investor sentiment has reached various levels of bearishness throughout the year, for all the well-documented reasons, and July had the potential to fulfil much of many investors' fears. There was a residual fear that, so far, the fall in equity markets was due to pricing in higher bond yields and not reflecting the possibility of weaker earnings. So although stocks, US ones, in particular, were starting to look better value, a weak earnings season would lead to further earnings downgrades that the market had not yet priced in. So far, Q2 2022 earnings reports have been no worse than analysts have been forecasting and may, depending on how the second half of the season goes, be modestly better than anticipated. Below, we go through many of the companies in our portfolio that have reported in the past month. With a few exceptions, the season was encouraging for our portfolio as many of the companies we own have managed to maintain pricing and margins in these inflationary times.

Total Return Balanced and Total Return Equity Portfolio Review

We review the holdings below.

Hermes reported a 29% increase in revenue for H1 and an increase in operating margin to 42%. New stores helped drive growth in the omnichannel network and online sales, and wholesale increased as travel retail resumed. Hermes recently announced a share buyback program of more than 500 million euros. The shares rose over 5% on the day of the announcement.

Although 3M's revenue fell 3% last quarter, this was better than analysts' forecasts and excluded a one-time litigation reserve charge; earnings were above estimates. 3M announced its healthcare division's spinout, expecting to retain 20% in the new publicly traded business. The new company will focus on the wound and oral care, healthcare IT and biopharma filtration. The industry generates $8bn in revenue, and the transaction will aim to complete at the end of next year. 3M is also simultaneously spinning off its food safety business. 3M also addressed investor concerns regarding the litigation it is facing related to combat arms earplugs and PFAS. 3M appears to follow a path trodden by J&J when facing similar issues by filing bankruptcy of its wholly owned subsidiary Aearo Technologies, setting aside a billion dollars to deal with settlement claims.

Despite missing earnings estimates and growth, Microsoft provided a reassuring forward guidance for the remainder of the year. Azure cloud services grew 46% and are now generating $100bn run rate revenue, representing half of Microsoft's group revenue. Trading at 16.8x cash-adjusted earnings, Microsoft represents supreme quality hyper-growth at a reasonable price. The shares reacted well to the earnings call.

SAP cloud services also drove a growth of 13%. The group reported €7.5bn revenue this quarter, assisted by the dollar's relative strength against the euro. The company cut profit guidance for the remainder of the year, partially due to product mix, a lower return from its venture investments, and the H1 revenue hit of €350m due to the exit from Russia. SAP repurchased about €997 million of stock in the quarter and increased its share buyback authorization by another €500 million. The stock has not had the best of years, but we think the de-rating on an essentially unchanged outlook remains harsh for a global business.

Sanofi raised full-year guidance for EPS growth of 15% due to strong sales for its anti-inflammatory treatment drug Dupixent which grew 43% in the last quarter. Group operating income increased 22% last quarter, beating analyst estimates. Sanofi and development partner GSK is still waiting to hear back from regulators on their protein-based COVID-19 vaccine candidate, modelled on the Beta variant.

Reckitt Benckiser announced strong revenues.......*FOR FULL REVIEW OF HOLDINGS PLEASE EMAIL*

Summing up our earnings season, the majority of the companies in our portfolio have managed to weather the slowdown and have the ability to pass on the majority of the rising input costs, maintaining margins despite some seeing hits to revenues.

Market Overview

The recovery this month in stocks can be put down to a combination of an earnings season that, so far at least, was no worse than expected, a market where sentiment was at rock bottom, along with renewed hope the Federal Reserve could engineer falling prices without an economic recession. The recent recovery in stock markets coincided with weakness in the US dollar, and we believe the correlation between the dollar and stock markets will continue into the second half. Many companies, particularly those based in the US, referred to the stronger dollar's impact on their results.

Although continued volatility in the second half of the year is likely, the defensive nature of the portfolio has benefitted us so far this year; we remain hopeful this will continue. We constantly remind ourselves that times like these are where the opportunities come for the longer term.

For performance figures please see factsheets on "Strategies" page or contact robert@cubecapital.co.uk

Yours sincerely

Cube Capital