World View

Vermeer Monthly – August 2022

4th August 2022

After a very difficult first half of the year, global equities performed very strongly in July. The results season has so far proven to be more resilient than feared and investors have sensed a peak in the inflationary pressures that have overshadowed markets in 2022.

As expected, the Federal Reserve maintained its very aggressive stance on rate increases to try and move to a far more restrictive monetary policy stance. At the same time as the Fed is trying to play catch up, having been far behind the curve, the US economy has shown considerable signs of slowing and in fact an initial read of second quarter GDP already places the economy in a technical recession.

The European Central Bank and many other central banks around the world have also moved aggressively to try and normalise monetary policy with the exception of Japan who are steadfastly maintaining their loose policy. This has led to a substantial weakening of the Yen in 2022, although this did finally somewhat reverse course towards the end of July.

At the July FOMC meeting, the Federal Reserve increased interest rates by another 75bps to 2.50%, citing a determination to continue to bring inflation down to 2% and the backdrop of a still very tight labour market as providing ample scope for further rises in the coming months. Fed Chair Jerome Powell noted the considerable difficulty of economic forecasting in the current environment as the inflation effects from supply chains continue to persist and wage costs continue to rise as unemployment remains low and the labour force participation rate shows no signs of increasing. The pace of hiring is slowing, and this is going to be equally important for policy setting in the coming months as part of the Federal Reserve’s dual mandate of managing inflation and unemployment. The real debate around inflation is not whether inflation will fall from the current highly elevated levels, but far more around what level it will persist. Interest rate expectations suggest that in the second quarter of next year, the Fed will once again be easing policy. However, this is going to be very difficult if inflation gets stuck at around the 4% level, which is becoming an increasing concern of many economists that we follow.

The results from Davide Campari-Milano and Moncler, two Italian based businesses held in the Fund, show the clear benefit of the strength in the Dollar as US consumers travelled to Europe to spend their strong currency. This comes as people have once again been free to travel without severe COVID related restrictions and this provided some much needed support to the otherwise weak economic environment in Europe. The European economy continues to be impacted by persistently high gas and energy prices. These are providing a considerable headwind, which could be set to worsen materially as we head into winter, especially if supply from Russia is severely restricted or even completely shut off.

Despite this overhang on the European economy, Davide Campari, the international spirits company, highlighted in its recent results the increasing popularity of its brands in the US and also in Italy, where Aperol continues to go from strength to strength having been the key driver of growth in recent years. Luxury goods company Moncler also noted considerable strength in its US business, more than offsetting weakness in China, which continues to be materially impacted by the ongoing zero-COVID policy and its subsequent lockdowns which show no sign of coming to an end. Moncler did note that when China started to partially reopen in June, demand picked up notably quickly, highlighting their continued appetite for luxury goods.

Amazon’s results towards the end of the month proved to be better than the market’s worst fears as the retail business showed no sign of macro headwinds affecting so many other retailers, notably Walmart which issued a substantial profit warning in late July. Amazon is clearly showing signs of honing its capital expenditure and is reigning back spending on warehousing and fulfilment centres. However, it is accelerating capex in AWS, its cloud infrastructure franchise, where growth trends are still excellent and driving overall group profitability. Cloud infrastructure growth was also a notable feature of both Microsoft and Alphabet’s results. All three companies continued to emphasise their clear belief that it is still very early in the adoption cycle for the cloud, which has been such a strong feature of the digital transformation which has accelerated markedly since the outbreak of the COVID pandemic.

Schneider Electric, the French based electrical engineering company, also demonstrated very resilient results. The company upgraded its full year guidance as spending trends towards sustainable energy supplies and factory automation are becoming more and more critical to companies that are increasingly anxious about energy efficiency and labour shortages. Management noted that demand for integrating digitalisation for efficiency and electrification for decarbonisation is being boosted by the acceleration of the energy transition. These are powerful secular growth drivers, and we believe the company is very well positioned for the future. Schneider shares enjoyed a strong rally in July after enduring a very difficult first half of the year.

Many companies are struggling with higher costs from a variety of sources, including the supply chain, energy costs and labour. None more so than gold miner Newmont, which saw its shares fall around 13% on the day of its results as the impact of lower gold and copper prices combined with a 12% increase in costs crimped profitability. However, the company still managed to generate over $500million in free cash flow and has ample scope to maintain its $2.20 per share annual dividend as long as the gold price does not suffer a material fall from current levels.

We maintained cash levels of around 10% during July as we remain cautious about the outlook for the global stock market, although we are of course delighted that there has been a strong rally after such a difficult start to the year. Valuations for many companies are no longer as stretched as they were, and it is notable that high quality companies who have pricing power are proving to be far more resilient when they are issuing their results. This is offsetting rising costs and at this point, seeing continued reasonable strength in the demand outlook.

Rarely, if ever, have there been so many economic cross currents for investors to deal with at the same time. The ongoing war in Ukraine and heightening geopolitical tension elsewhere, alongside rising interest rates at a time when the global economy is on the brink of recession, exacerbated by sharply rising energy costs and still impacted supply chains are all material challenges that companies are facing. US quantitative tightening is only just beginning, and we are yet to see what impact this is likely to have on asset prices in the future. As noted earlier, the rate at which inflation persists as we move into 2023 is ultimately going to be a key driver of markets as it will dictate how fast monetary policy can be eased in response to what is likely to remain a weak economic environment.

Tim Gregory
Senior Fund Manager
Vermeer Investment Management