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Research Coverage
July 2022
Important Information:
This webinar contains information specifically intended for institutional clients, asset consultants, advisers, platforms and researchers, who are professional investors and wholesale clients (as defined in the Corporations Act 2001).
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With global equity valuations coming under pressure due to surging inflation, rising interest rates and elevated commodity prices, the outlook for investors continues to provide uncertainty. On a recent research visit to the US, Portfolio Manager, Adrian Martuccio sat down with various portfolio company management teams to discuss their outlook and business confidence, as well as the impact of inflation on consumer demand and supply.
We share a summary of his views and unpack some of the ideas and themes that were addressed. Despite the ongoing list of negatives that investors are facing, there are still a number of positive items that support ‘quality’ when it comes to taking a long term view on global equities.
US insights – what you need to know
As we look at the state of the US economy, global company management teams exhibited similar viewpoints about the high likelihood of a recession with the vast majority being more sanguine that a slowdown/recession will ease supply chain bottlenecks. Many businesses believe that supply chain issues are still widespread, primarily labour driven with smaller companies, though these backlogs will likely decline by the end of the year as inventory gets replenished.
As recession uncertainty continues, sectors such as manufacturing and selective retail are seeing elevated inventory levels becoming the heart of the problem in their businesses, partly due to growing backlogs, long transit times and over-ordering.
Concerns are also mounting about the impact of escalating inflation levels, which has seen the US reach a 40 year high inflation level of 9.1% in June 2022. According to Adrian Martuccio, employee shortages are rife across the nation and inflation continues to be well anchored compared to last year. While investors adjust their expectations of the inflationary pressures they face, we believe that US household and bank balance sheets remain healthy.
One thing is certain, a combination of soaring inflation, slowing growth and high company margin expectations is taking place, as the hiking of interest rates on equity valuations evolves into investor worries. The consensus is that company forecasts need to come down and margins across the board are far too high. Management teams believe that stock prices have factored this in, but we believe it will become difficult for companies to rally convincingly in the face of downgrades - with investors now questioning whether company earnings will moderate as both demand and margins come under pressure.
Growth sectors under pressure
Software and biotech industries, once lucrative and heavily weighted growth sectors, have seen valuations come under significant pressure in the listed space and private companies are now experiencing funding drying up. We believe valuations in the private space will further reduce once companies in these sectors become desperate for the next round of capital inflow or when venture capitalists decide to exit. The US is already entering a new phase of a downturn, and it’s expected that there will be plenty of ‘down-rounds’ that will become painful from an investor’s perspective.
Regardless of the fact that slower or negative growth has increased materially for information technology sectors, many tech startups are starting to experience job losses as they try to reduce the bleeding of cash. It was evident from our discussions that many larger tech companies that have recently struggled to attract talent due to many startups offering stock (which are now deeply underwater as stock prices plummet),and are finding more talent coming to the market wanting a new and stable job. This instability in the US jobs market, not just in software/cloud but consumer companies, is becoming more challenging as companies find that they need to be rational with their decisions to pivot and sustain their businesses.
A snapshot of how the US and global economy is performing as it signals a historic downturn
Capturing ‘Quality’ in a volatile and uncertain market
This year’s global market correction reflects several concerns about the economic future. From a stock perspective, sharp declines across equity portfolios are putting investors under severe pressure to hold long-term return potential. In our experience, lower volatile portfolios focused on high quality companies with low levels of debt and high cash flow are an essential indicator of ‘Quality’. They have the potential not only to provide superior risk-adjusted returns, but they may also exhibit defensive characteristics in times of market volatility. We expect that ‘Quality’ as a style will generate material alpha in this current environment.
Early in the downturn, higher quality companies were outperforming and this crisis has been quick to unmask inherent financial frailty of companies that exhibit a combination of stretched balance sheets, capital intensive businesses and economically sensitive earnings. We believe this trend should continue through the economic slump and in the early stages of the recovery – providing opportunities for investors.
How are we positioned in this environment?
Our portfolios remain fully invested, and whilst we adjust our expectations for this evolving environment, our ‘Quality at a Reasonable Price’ or ‘QARP’ style (investing in high quality businesses while not overpaying for them) we believe our valuation discipline has and will continue to hold us in good stead in challenging periods. As the market experiences further weakness, there are several opportunities that we have been following and we will likely see more eventuate throughout 2022. Investors should always remember that economic downturns aren’t forever and should take a long-term view on their global equities which will help to position their portfolio for an uncertain future ahead.
IMPORTANT INFORMATION
1 Effective 16 June 2022. Source: US Federal Reserve System https://www.federalreserve.gov/monetarypolicy/fomcminutes20220615.htm
2 As at 7 June 2022. Source: The World Bank https://www.worldbank.org/en/news/press-release/2022/06/07/stagflation-risk-rises-amid-sharp-slowdown-in-growth-energy-markets
3 Annual inflation rate as at 30 June 2022. Source: Bloomberg US CPI June 2022: Inflation Accelerates to 9.1%, Once Again Exceeding Forecasts - Bloomberg
4 As at 30 June 2022. Source: European Central Bank, Eurosystem https://www.ecb.europa.eu/stats/html/index.en.html
5 As at 28 June 202. Source: The US Conference Board US Consumer Confidence (conference-board.org)
6 Monthly rate, as at 30 June 2022. Source: U.S Bureau of Labour statistics https://www.bls.gov/charts/employment-situation/civilian-unemployment-rate.htm
IMPORTANT INFORMATION
This article was prepared for Bell Asset Management Limited (BAM) ABN 84 092 278 647, AFSL. Distribution by Channel Capital Pty Ltd ACN 162 591 568 AR No. 001274413 (Channel). Neither BAM nor Channel warrant the accuracy, reliability or completeness of the information. This article has been prepared by BAM for information purposes only and does not take into consideration the investment objectives, financial circumstances or needs of any particular recipient – it contains general information only. No representation or warranty, express or implied, is made as to the accuracy, completeness or reasonableness of any assumption contained in this report. Past performance is not necessarily indicative of expected future performance.
With global equity valuations coming under pressure due to surging inflation, rising interest rates and elevated commodity prices, the outlook for investors continues to provide uncertainty. On a recent research visit to the US, Portfolio Manager, Adrian Martuccio sat down with various portfolio company management teams to discuss their outlook and business confidence, as well as the impact of inflation on consumer demand and supply.
We share a summary of his views and unpack some of the ideas and themes that were addressed. Despite the ongoing list of negatives that investors are facing, there are still a number of positive items that support ‘quality’ when it comes to taking a long term view on global equities.
US insights – what you need to know
As we look at the state of the US economy, global company management teams exhibited similar viewpoints about the high likelihood of a recession with the vast majority being more sanguine that a slowdown/recession will ease supply chain bottlenecks. Many businesses believe that supply chain issues are still widespread, primarily labour driven with smaller companies, though these backlogs will likely decline by the end of the year as inventory gets replenished.
As recession uncertainty continues, sectors such as manufacturing and selective retail are seeing elevated inventory levels becoming the heart of the problem in their businesses, partly due to growing backlogs, long transit times and over-ordering.
Concerns are also mounting about the impact of escalating inflation levels, which has seen the US reach a 40 year high inflation level of 9.1% in June 2022. According to Adrian Martuccio, employee shortages are rife across the nation and inflation continues to be well anchored compared to last year. While investors adjust their expectations of the inflationary pressures they face, we believe that US household and bank balance sheets remain healthy.
One thing is certain, a combination of soaring inflation, slowing growth and high company margin expectations is taking place, as the hiking of interest rates on equity valuations evolves into investor worries. The consensus is that company forecasts need to come down and margins across the board are far too high. Management teams believe that stock prices have factored this in, but we believe it will become difficult for companies to rally convincingly in the face of downgrades - with investors now questioning whether company earnings will moderate as both demand and margins come under pressure.
Growth sectors under pressure
Software and biotech industries, once lucrative and heavily weighted growth sectors, have seen valuations come under significant pressure in the listed space and private companies are now experiencing funding drying up. We believe valuations in the private space will further reduce once companies in these sectors become desperate for the next round of capital inflow or when venture capitalists decide to exit. The US is already entering a new phase of a downturn, and it’s expected that there will be plenty of ‘down-rounds’ that will become painful from an investor’s perspective.
Regardless of the fact that slower or negative growth has increased materially for information technology sectors, many tech startups are starting to experience job losses as they try to reduce the bleeding of cash. It was evident from our discussions that many larger tech companies that have recently struggled to attract talent due to many startups offering stock (which are now deeply underwater as stock prices plummet),and are finding more talent coming to the market wanting a new and stable job. This instability in the US jobs market, not just in software/cloud but consumer companies, is becoming more challenging as companies find that they need to be rational with their decisions to pivot and sustain their businesses.
A snapshot of how the US and global economy is performing as it signals a historic downturn
Capturing ‘Quality’ in a volatile and uncertain market
This year’s global market correction reflects several concerns about the economic future. From a stock perspective, sharp declines across equity portfolios are putting investors under severe pressure to hold long-term return potential. In our experience, lower volatile portfolios focused on high quality companies with low levels of debt and high cash flow are an essential indicator of ‘Quality’. They have the potential not only to provide superior risk-adjusted returns, but they may also exhibit defensive characteristics in times of market volatility. We expect that ‘Quality’ as a style will generate material alpha in this current environment.
Early in the downturn, higher quality companies were outperforming and this crisis has been quick to unmask inherent financial frailty of companies that exhibit a combination of stretched balance sheets, capital intensive businesses and economically sensitive earnings. We believe this trend should continue through the economic slump and in the early stages of the recovery – providing opportunities for investors.
How are we positioned in this environment?
Our portfolios remain fully invested, and whilst we adjust our expectations for this evolving environment, our ‘Quality at a Reasonable Price’ or ‘QARP’ style (investing in high quality businesses while not overpaying for them) we believe our valuation discipline has and will continue to hold us in good stead in challenging periods. As the market experiences further weakness, there are several opportunities that we have been following and we will likely see more eventuate throughout 2022. Investors should always remember that economic downturns aren’t forever and should take a long-term view on their global equities which will help to position their portfolio for an uncertain future ahead.
IMPORTANT INFORMATION
1 Effective 16 June 2022. Source: US Federal Reserve System https://www.federalreserve.gov/monetarypolicy/fomcminutes20220615.htm
2 As at 7 June 2022. Source: The World Bank https://www.worldbank.org/en/news/press-release/2022/06/07/stagflation-risk-rises-amid-sharp-slowdown-in-growth-energy-markets
3 Annual inflation rate as at 30 June 2022. Source: Bloomberg US CPI June 2022: Inflation Accelerates to 9.1%, Once Again Exceeding Forecasts - Bloomberg
4 As at 30 June 2022. Source: European Central Bank, Eurosystem https://www.ecb.europa.eu/stats/html/index.en.html
5 As at 28 June 202. Source: The US Conference Board US Consumer Confidence (conference-board.org)
6 Monthly rate, as at 30 June 2022. Source: U.S Bureau of Labour statistics https://www.bls.gov/charts/employment-situation/civilian-unemployment-rate.htm
IMPORTANT INFORMATION
This article was prepared for Bell Asset Management Limited (BAM) ABN 84 092 278 647, AFSL. Distribution by Channel Capital Pty Ltd ACN 162 591 568 AR No. 001274413 (Channel). Neither BAM nor Channel warrant the accuracy, reliability or completeness of the information. This article has been prepared by BAM for information purposes only and does not take into consideration the investment objectives, financial circumstances or needs of any particular recipient – it contains general information only. No representation or warranty, express or implied, is made as to the accuracy, completeness or reasonableness of any assumption contained in this report. Past performance is not necessarily indicative of expected future performance.
