SGH Australia Plus (ETL0383AU) Report & Performance

In April the ASX300 declined -0.8%, but relatively outperformed US equities with the S&P500 down -8.7% and NASDAQ falling 13.2%. The main driver was a more hawkish Federal Reserve, which hiked its official cash rate 50 basis points to 1%, indicated additional 50 basis point increases were be “on the table” at the next couple of FOMC meetings, and formally announced the start of quantitative tightening and decision to shrink its balance sheet from 1 June. This has had the impact of pushing up real yields and putting more pressure on valuations. This was most evident in the derating in growth and technology stocks, but also felt in interest rate sensitive sectors like housing and REITs.

There is no set playbook for returns when rates start to rise, but looking back at periods when this has been the case the common thread is valuations typically fall. The price earnings ratio of the ASX200 has fallen considerably since the start of the year and is now back close to its 20-year average of 14x. However, it reflects more the contraction in resource company multiples on higher (peak) earnings than necessarily the derating in high growth stocks. Growth stock valuations are still around 30% above 2018 levels, whilst nominal rate expectations are now close to 2018 peak hawkishness. This suggests there is potential for further contraction in valuations.

The Fed’s more hawkish stance has also raised concerns Central Banks will be tightening into a slowing cycle and raised the spectre of stagflation (higher inflation and rates and slowing economic growth) and mid cycle slowdown, or worse recession. Global growth estimates have been coming down over recent months with the Russia-Ukraine crisis and Chinese lockdowns. The risk Europe goes into recession seems increasingly probable. We see US and particularly Australia as overall better placed to absorb higher rates

For the month the portfolio returned 6.68% underperforming the S&P/ASX300 Accumulation Index by -0.21%. During the month we added Netwealth Limited (NWL) to the portfolio. NWL is a specialty platform provider with strong growth in Funds Under Advice driven by a superior technology stack that is resulting in market share gains from the incumbent platforms including ANZ, IOOF, MLC and BT Panorama.

Uniti Group (UWL) was the beneficiary of a takeover bid from two independent parties; the Morrison – Brookfield Infrastructure Group consortium, and secondly, a rival bid from Macquarie Infrastructure and Real Assets (MIRA). The competing bids highlight the reason we were attracted to UWL initially – long duration social infrastructure type assets with stable and recurring revenue streams.

Equity markets continued their volatile start to the year in February. The invasion of Ukraine by Russian forces late in the month added to existing concerns around rising inflation and interest rate expectations and impeding monetary policy tightening that has consumed the market since the start of the year. Despite this the ASX300 Accumulation Index finished up 2.09%, outperforming the MSCI Global Index (-5%) and global indices. The consumer staples (+5.8%) and energy (+5.6%) were strong performers for the month, whilst the technology sector underperformed (-4.6%),

The Australian February reporting season provided the opportunity to gain a broad insight into the underlying economy and operating environment. By and large, the results season was solid with around 90% of companies reporting top line revenue growth in-line or better than consensus and 49% of companies beating earnings expectations. Aggregate earnings for the ASX200 for FY22 was revised upwards by approximately 2% with earnings growth now expected to be close to 13-14% for the 2022 financial year.

The Australian market was down 6.5% in January after rising 2.8% in December. Volatility was again a centrepiece of equity markets during January driven by concerns the Omicron strain has exacerbated supply chain issues and amplified cost pressures adding to inflationary concerns. Recent economic data has also done little to offer any respite that The Federal Reserve and RBA are behind the curve and need to be seen to be doing something about inflation.

Discussion during Jerome Powell’s January Congressional Testimony that the Federal Reserve may start shrinking its balance this year further added to market nervousness. The last time we had rate hikes plus QT in late 2018 the S&P500 fell around 20%! The Australian market was not immune to the more aggressive Fed language, and a higher-than-expected domestic CPI result coupled with a lower unemployment rate have led to increased pressure on the RBA for policy tightening. In keeping with the shift in market sentiment and rising inflationary and rate expectations cyclical and value sectors outperformed in January. Energy (+7.9%) was the top performing sector with Utilities (+2.6%) and Materials (+0.8%) the only other positive sectors. More long duration and growth sector fell the most with Info Tech (-18.4%) and Health Care (-12.1%). This also saw large caps preferred over mid and small caps, while Resources outperformed Industrials across all size bias indices. MSCI Value outperformed MSCI Growth by 8.5% in the month.

The quarter was defined by the emergence of the Omicron wave of the virus and hawkish pivot by the Fed now it no longer sees inflation as ‘transitory’.

 There is no set playbook for returns when the Fed raises rates but looking back at periods when this has been the case the common thread is valuations typically fall and returns are driven by earnings and dividends.

 The quandary is navigating the prospects of reopening and better earnings as supply shocks ease and peaking in inflation, against more hawkish central bank policy if supply chain issues and inflation persist.

 We continue to favour selective reopening trades and higher cyclical exposure which not only stand to benefit as demand recovers from the pandemic but also as rates tighten. We also think it’s important to maintain a diversified portfolio and retain a healthy position to quality growth companies with a margin of safety.

 In positioning for the prospects of reopening, tapering and more persistent inflationary pressures we added Computershare and increased our commodities and energy exposures. We also initiated a position in EBOS.

 The Fund returned 2.24% in the December quarter outperforming the S&PASX300 Accum. Index by 0.03%. The top portfolio contributors were National Australia Bank, Macquarie Bank and Cooper Energy whilst Marley Spoon, Alibaba and Carbon Revolution were the largest detractors. Cash at the end of quarter was 2.2%.

The Australian S&P/ASX300 Accumulation Index closed down -0.53% in November, but outperformed global indices with Developed markets declining -1.4% and Emerging markets -3.2%. Volatility was a centrepiece of equity markets during November. Early in the month, the tailwind of the broader economic recovery helped push markets and inflation expectations higher but was met intra month by more hawkish commentary from central banks, most notably with the Fed announcing its tapering plans. This was largely anticipated and saw markets trade higher before the emergence of the Omicron strain and onset of renewed concerns around lockdowns and economic growth.

Consistent with our approach to date in managing the uncertainty created by Covid, and learning to live with the virus, we see it as important to not jump to conclusions based on bogus assumptions and things we do not know and cannot know. Rather, our approach continues to be to try and understand what is going on rather than suggest we know what’s going on, manage risk and embrace the uncertainty where it is sensible to do so.