Please find below our Investment Market Update as at 6th May 2022, written by Andrew Dunn (aka Gus).
It’s all about interest rates this week
The first announcement was made by the Federal Reserve in the United States with a 0.5% increase, the largest in over 20 years. Many commentators had said that the Fed were ‘behind the curve’ meaning that they had left this rise too late to cool the economy and assist in a so-called soft landing for the economy.
In large part this has contributed to the weakness seen in stock markets these last few months, and especially within Growth stocks which are highly sensitive to rising interest rates – partly due to the extra cost of borrowing for expansion but also the technical way in which their future profitability is assessed by the market.
The rise was much less than had been expected and the US market reacted positively with all main indices up circa 3% on Wednesday and the value of the dollar fell. A further fillip was the comment around further rises being on the table for the next couple of Fed meetings, again potentially far fewer than had been thought, and priced in. Jerome Powell, Chairman of the Fed, did say they would have to remain nimble giving himself scope to increase rates higher in the light of more data.
The US economy continues to perform very strongly, with their labour market in particular showing far more vacancies than potential employees. In part this reflects the economic post-covid growth but also the fact that the pandemic convinced many workers to retire, or at least take an extended break. This all feeds into inflation and Powell said “inflation is much too high and we understand the hardship it is causing… we are working expeditiously to bring it back down”.
Interest rates is part of this strategy as is the gradual withdrawal of government support via its strategy of buying bonds from the market to support cash flowing through the economy. The Fed also announced the rate of this withdrawal would be more gradual than had been planned, another measure of support for the economy.
The very next day, the market decided that the news was not as good as they thought, that inflation remained a concern and, as a result, all of Wednesday’s gains were given back. This 24-hour turnaround encapsulates the last few months with a seesaw of sentiment from one moment to the next. This volatility is unsettling but is unfortunately part and parcel of investing and another reason to endeavour to look beyond short-term movements to long-term plans and fundamentals.
UK interest rates – same issue but with different challenges
The Bank of England has increased rates by 0.25% up to 1%, the highest level in 13 years. They also stated that they see inflation rising a little further into this Autumn and that our economy will contract this year. The challenge for the Bank is the same as the United States – how to calm inflation – but they do not have the relative luxury of a very strong economy.
They are therefore seeking a balance between bearing down on rising prices without pushing into ‘Banana’ (recession) as Gary discussed in last week’s commentary. There was much speculation about a higher 0.5% rise so clearly the Committee have a weather eye on our wider economic outlook. Here there are, as ever, mixed signals from which to draw conclusions. Business confidence has dropped to its lowest level in 18 months, with the important service sector coming off the boil. Though the service sector showed marginal growth in April, benefitting from the loosening of covid restrictions, it was at a level lower than hoped for. Supply issues remain a challenge for many, especially the UK car industry with April new registrations down 15% and fleet sales being particularly hit.
To set against this, company results for now remain buoyant and indeed we may be seeing some slightly more promising signs from the hard put Retail sector with Next delivering strong sales growth – online sales down but shop sales well up. Unsurprisingly, Shell announced a huge rise in profits this week and, positively for the UK, that they plan to move their headquarters from the EU to London.
The stock market reaction to the latest interest rate announcement was very muted with the US market demonstrating again its Svengali-like influence over our home market.
Economic outlook for the rest of the world
Just a quick overview of the other main markets; European markets initially benefitted from the US rate news, but it remains a case of snakes and ladders with a rise one day and fall back the next. The European Central Bank has arguably the most difficult choice about what to do with interest rate rises, as they also have rampant inflation but muted growth against a backdrop of the Ukraine situation. There is no immediate plan to raise rates and no consensus either with members disagreeing about a next move that is unlikely to come before July.
The Chinese stock market has been flat on the back of economic data showing a contraction in the world’s number two economy, right the way from weak services and factory output to a plunge in domestic travel spending. A delay in Shanghai’s final exit from a five-week lockdown and fresh regulatory headwinds from Washington unsettled investors further.
“Investors remain cautious about the market. The main concern still surrounds the impact of lockdowns on the economy” said Banny Lam, Head of Research at CEB International Investment Corp. “Other concerns include Chinese enterprises’ delisting issue in the US.”
The Government also sought to ease fears of an extended crackdown on private enterprise, especially in the technology sector which had previously been so strong. China’s central bank said it will implement “normalized” supervision on the financial activities of online platform companies and that support for technology innovation companies should be strengthened.
Digital Infrastructure and the 4th Industrial Revolution
All our clients will know that we remain very keen on investing into Infrastructure and, in fact, we have been active recently to add yet more funds. We see many attractions from the inflation linking of their contracts/income, the fact that they hold physical assets, the way it can act as a diversifier to reduce risk and the highly diverse nature of the underlying investments that are now termed ‘Infrastructure’. The following is an article taken from Trustnet and focusses on digital infrastructure, which is perhaps less well known than some more conventional assets.
Just as power, water and road infrastructure are essential for us to live our everyday lives, so digital equipment and systems are becoming equally important. But it was the global pandemic which really highlighted the importance of this area to society.
For example, while many of us knew doctors and nurses were seen as key workers during the pandemic – did we all know that people working in mobile towers and data centres were given the same status?
In fairness, we were not completely blind going into the pandemic. For almost two decades, the US government has classed digital infrastructure as ‘critical infrastructure’ – an integral component to the functioning of modern-day society and its economy.
But the events of the past two years really have accelerated the trend as the demand placed on networks, data storage and processing facilities has been growing significantly as internet and device connections and the usage of new data-intensive technologies have expanded.
By 2025 we could see as many as 5,000 digital interactions per user per day – that’s astounding when you think about it. Despite this, our digital infrastructure is way behind where it needs to be. For example, more than half the global population is still unable to access the internet.
And there is a two-speed growth dynamic taking place within digital infrastructure globally. On one level you have Western countries looking to move from 4G to 5G. While they have good existing digital infrastructure, it needs to be both upgraded and expanded. Faster downloading of items or improving online gaming are examples which come to mind.
The other part of the story is emerging markets. Many of them are moving from 2G to 3G but they won’t have the mobile towers or data centres the developed world has, so the story is only just kicking into gear.
According to a McKinsey lobal Survey of executives, their companies have accelerated the digitisation of their customer and supply chain interactions (as well as their internal operations) by three to four years, while the share of digital or digitally enabled products in their portfolios has accelerated by seven years.
To put this into context, figures show that in December 2019, the percentage of digital customer interactions stood at 36%. This rose to an astounding 58% by July 2020. I expect those figures will have fallen slightly as the world economy re-opens but will be nowhere near the original figure again.
Importantly, the pandemic has created a paradigm shift in many of our work and living patterns. As M&G Global Listed Infrastructure manager Alex Araujo said “The shift will be somewhat permanent with more flexible working arrangements, and, in some cases, digital infrastructure will replace the need for transportation infrastructure, where people choose to hold meetings virtually rather than face-to-face, at least in the short-to-medium term.
“Where we end up long-term is still an open question but there is no doubt digital infrastructure will have an increasing level of importance and influence in our work and even how we entertain ourselves.”
Clearly, more needs to be done. An Ernst & Young report in collaboration with the Digital Infrastructure Providers Association (DIPA) estimated the sector needs an investment of up to $23 billion by 2025, to support the growing demand for digital services and rising online traffic.
The report found as many as 330 million people will be using 5G, while sectors such as e-commerce, education and healthcare will grow their presence online. To meet the demand, it says investment in the range of $7-$9 billion each for macro tower additions and fibre deployments, $2-3 billion for outdoor small cells which will be important for 5G the roll out, $500-800 million in Wi-Fi and in-building solutions, $500-700 million in edge data centres and $500 million in data centres.
In many parts of the world, including wealthy nations such as the US, the UK and Germany, companies are scrambling to build the networks needed to keep up with this explosion in data generation and usage.
The so-called Fourth Industrial Revolution, in which digital technologies pervade every area of life, is well under way.
This huge rise in data usage has come in tandem with a need to replace old copper and fibre optic cables – so the story is about both growth and renovation. As Matthew Norris, Head of Real Estate Securities at Gravis points out – in just one minute on the internet, there will have been 5.7 million google searches conducted and 272,000 apps and games downloaded.
Simply put, we need the physical networks to enable that transmission – it needs to grow, and fast.
There has been a great deal of comment about the so called ‘big 5’ with their company results recently released and,of course, Elon Musk’s purchase of Twitter. More often than not, they are treated as a proxy for the whole sector and with the rise of passive funds they are a critical part of US and World indices. Our friends at LGT Wealth have provided for us the following summary of the results, their approach and outlook.
The results season for Q1 of 2022 has come to a close for the Big Tech behemoths. This can be a good signal of the ‘growth’ investing factor, although parts of these businesses have now become defensive in their nature due to their pricing power and strong economic moats. Below is a roundup of the ‘Big Five’.
Alphabet (parent company of Google)
Despite its size, revenue is still growing at 20%+ per annum. Growth has slowed quarter on quarter, however, it’s still in line with the rate it was growing at pre-pandemic. Also, the company since then has surpassed nine properties with over one billion users (Android, Chrome, Gmail, Google Drive, Google Maps, Search, Google Photos, Google Play Store and YouTube); 20%+ growth at this scale remains remarkable. The share price fell -4% after-hours following its results.
On the earnings release conference call, management pointed out that travel-related searches in Q1 2022 were above Q1 2019 pre-pandemic levels, and that searches for ‘shopping near me’ rose 100% globally, as consumers balance shopping online and in-person.
Q1 2022 revenue rose 7% year-on-year (YoY), on a +44% comparison to Q1 2021 and +26% comparison to Q1 2020. Revenue from Amazon’s own online store (44% of total revenue) fell 3% YoY on a tough +44% comparison. This was only the second ever decline (the first being last quarter).
Amazon was a huge relative winner from the pandemic as everyone was forced to shop online. Comparisons now are versus the height of the company’s growth and were expected to be challenging.
Despite an incredibly tough comparison (+54%), revenue rose 9% YoY. That’s 67% on a two-year basis, and nearly $40 billion of quarterly revenue added in two years. Some quite unbelievable numbers.
On the earnings release conference call, management reported their YoY revenue performance during the Q2 of 2022 will be impacted by a number of factors; supply constraints caused by covid-related disruptions and industrywide silicon shortages are impacting their ability to meet customer demand for products. The covid-related disruptions are also having some impact on customer demand in China.
Meta (formerly Facebook)
With the market locking its eyes on user growth, numbers from Meta Platforms appeared impressive, despite the slowest revenue expansion since the company went public. Daily active users rose 4% to 1.96 billiontopping expectations, while monthly active users rose 3% to a generally in-line 2.94 billion. Shares of the social network soared more than 16% in after-hours trading following the results.
Microsoft (note that this is top holding in the LGT WM Balanced portfolio)
The incredibly robust growth (especially for one of the world’s largest companies) continues, with Q1 2022 constant currency revenue growth of +20% YoY. That is four years of consecutive double-digit quarterly revenue growth (including through the covid-19 pandemic). Microsoft has been written-off several times over the past decade but has come back stronger each time.
As portfolio managers, we do not put much stall in how stocks move on the day of earnings, it’s the longer-term compounding that matters. This and last quarter’s reporting season are a couple of reasons why. Last time around Facebook fell 26% (losing $251 billion in market cap), and Amazon rose 14% (adding $191 billion in market cap). This quarter Facebook rose 18% (adding $82 billion of market cap), while Amazon lost around 9% (shedding $132 billion in market cap).
The LGT WM Model Portfolios
We have long had a quality growth bias in the portfolios and the companies mentioned fall into that basket. Even the figures, albeit tempered by comparisons to last year, are still extraordinary and show just how incredible the growth is that these companies have had in recent times.
The pandemic brought forward earnings for a lot of these larger tech companies, and we expect them to continue to grow at an attractive rate. It is also worth mentioning that there has been a re-rating in these stocks year to date and now trade at much more appealing multiples for our active managers to take advantage of. We are conscious of our quality growth bias, however, and have been balancing out this exposure with other, less richly valued sectors we like, such as insurance and healthcare / pharmaceuticals, which we gain exposure to from funds like Fidelity Global Dividend and Evenlode Global Income, amongst others.
Have a lovely weekend, whatever you are doing.
Gus and the Blue Sky Investment Team
Please Note: This communication should not be read as giving specific advice regarding your personal circumstances. This would only be given following detailed assessment of your individual needs. The value of investments may fall as well as rise; you may get back less than invested. Past performance is not necessarily a guide to future returns.