• Global equity markets rose in February with the FTSE All World Index returning +2.4%, and the Global Leaders Equity portfolio returns were in line with this +2.3%.
• A steepening yield curve, and confidence in an economic rebound due to successful vaccination programs saw some rotation in market leadership, with traditional value stocks, indebted companies and smaller capitalisation companies perform particularly well.
• Within the portfolio a new position was established in Eaton, a global leader in electrification set to benefit from accelerating secular trends. A Japanese index tracker was also added with several positions trimmed to make way for this. Pharmaceutical giant Merck was sold.
After their small dip in January, global equity markets continued to climb higher in February. There is growing confidence that vaccines will end economic lock downs and there will be a return to trend growth in many countries. Traditional value stocks, indebted stocks and smaller capitalisation companies performed particularly well. Some of this move is due to relief that economic conditions are expected to improve. Much of this move can be also be accounted for by changing expectations of monetary policy. A prolonged rise in inflation would force central banks to raise interest rates. The great inflation debate is on-going, and the truth is that no-one knows for sure what will happen. If there was one economic variable that the Ashburton Investment team would like to know for long term investment it would be the inflation outlook. On the one hand with close to a quarter of all US dollars in existence created by the Federal Reserve in just the last year, some economists confidently predict inflation. On the other hand, some economists argue that both technological advancements and the massive reduction in money circulation have huge deflationary effects. As President Truman once reportedly said “Bring me the one-handed economist” Only very few have predicted hyperinflation given that confidence in central banks appears to be solid.
While new variants threaten to come down the track, the light at the end of the pandemic tunnel is looking much closer for citizens of countries with advanced vaccination programs. Israel, the UAE and the UK lead the way on this front. Data from Israel and a recent publication from Public Health England indicates the massive reductions in COVID-19 cases and hospitalisations as a result of vaccine programs.
The best performers held during the month were Lloyds Bank (+20.4%), JP Morgan (+14.4%) and NXP Semiconductor (+13.8%). February saw a steeping of the yield curve that is favourable for banks along with positive news about the speed of vaccines roll outs in the UK and USA. NXP Semiconductor has been a beneficiary of a global chip shortage, leading to expectations that the company will be able to raise prices. The position in Lloyds Bank was increased and that in NXP Semiconductor was trimmed.
The worst performers held during the month were Unilever (-9.3%), Nestle (-6.7%) and Alibaba ( -6.3%). Exposure to consumer staples has been slightly reduced. Unilever disappointed investors on reported margins though maintained guidance, while despite Nestle’s encouraging results their share price also declined.
During the month a new holding was established in Eaton. The company holds a dominant position in the USA in many segments of electrification. The firm is set to benefit from secular trends in the electricals industry including increased investment in sustainability infrastructure, increased connectivity and increased electrical content. The firm has recently launched a digital platform, Brightlayer, which should result in increased sales opportunities. We do not believe the prolonged positive outlook for growth has yet been factored into consensus forecasts, nor the current share price.
Pharmaceutical giant Merck was sold. The increasing concentration on wonder drug Keytruda, set to become the world’s best-selling drug, has some echoes of Pfizer in the years in run up to the patent expiry of the world’s previous biggest ever selling drug Lipitor. During this period, despite trading on very low share price multiples Pfizer shares materially disappointed. While Merck is a high-quality company trading on a low multiple the team was conscious that this could be something of a classic “value trap”. The compelling case to add Eaton to the portfolio meant that with a 25 stock maximum holdings limit something had to be sold.
Finding companies that fit the Ashburton Global Leaders criteria in Japan has been something of an issue for the team. Relatively few companies meet our quantitative criteria, especially in generating returns ahead of their cost of capital. Capital allocation has not been a priority of Japanese business. Meanwhile the market has appeared to trade on depressed multiples for some time. A decision was made to add some modest exposure to the Japanese index while the team continues to look out for and analyse individual Japanese stocks.
There are signs of market excess perhaps in part due to increased retail participation and gamification of investment. The portfolio has been tilted towards sectors of the market that should benefit from a cyclical upswing while selecting stocks we believe to be undervalued.