World View

Vermeer Monthly – February 2024

9th February 2024

Global equities rose just over 1% in January with the Vermeer Global Fund returning 3% for the period helped by strong performance from key holdings including ASML, Microsoft, Nvidia, Cameco, Toyota Motor, Eli Lilly and Novo Nordisk. Japanese equities had a notably strong start to the year in local currency terms, with the Nikkei rising 8.4%, but this was once again negated somewhat by the weakness of the Yen, which fell by around 4% against Sterling in January alone.

Markets were led by similar trends that dominated market performance in 2023 as once again US interest rates and artificial intelligence were the dominant themes.

The Federal Reserve signalled in late 2023 that it believed three interest rate cuts were likely in 2024, while interest rate futures almost immediate priced in as many as six cuts over the same period. This looked to us to be a very aggressive positioning unless the US economy fell into a much sharper recession than is currently being forecast. Expectations for a first rate cut in March were also priced in, but this has subsequently been reduced sharply following the Fed meeting in January and the latest set of economic data in early February. At the January FOMC meeting, Chairman Jerome Powell stated that “based on the meeting today, I would tell you that I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting to identify March is the time to do that …. but that’s to be seen.” US economic growth remains robust and is expected to have been around 2.5% for 2023 according to the IMF who also upgraded their 2024 forecast from 1.5% to 2.1%.

Artificial intelligence remains a dominant investor theme as increased adoption, while really in its infancy, is a key driver to sentiment for many stocks. Once again shares in Nvidia led the US market higher, rising by 24.2% in January adding to its massive rise from depressed levels in 2023. Nvidia now has a market capitalisation of over $1.5trillion and is a 3.8% position in our portfolio. Both Alphabet and Microsoft announced significant increases in capital expenditure for servers and data centres to meet increasing demand for cloud services and AI related products, which bodes well for sustainable growth in GPU chip demand in 2024 and beyond.

ASML, the world’s leading manufacturer of lithography machines for chip makers reported results in January which we believe will mean 2024 will represent the bottom of the cycle and that revenue growth will reaccelerate in 2025 and enable the company to exceed the guidance it gave for both 2025 and 2030. Although short term results have been mixed, order intake in its most recent quarter was very strong, exceeding expectations by a very wide margin and driving a very strong share price response.

Microsoft produced another excellent set of results confirming that it is at the forefront of artificial intelligence, which is strengthening its position in cloud services and nearly all aspects of business IT infrastructure. On the earnings call, management stated that Azure cloud is still gaining share and growing at 30%. However, other aspects of the business are also doing well as the company increases its moat through the strengthening of its full service offering to customers and the early adoption of AI products like CoPilot which is in the process of being rolled out to many new customers. Microsoft’s confidence in its long-term growth prospects is highlighted by a substantial increase in capex for servers and data centres. Microsoft shares have been a strong performer in recent years and is currently the largest company in the S&P 500 by market capitalisation with the shares rising by just under 6% in January.

Alphabet produced what looked a fairly solid set of results, but the shares declined by 7%, wiping out most of the stock’s gains for the year. On the results call, management noted accelerated growth in its cloud franchise GCP and also very strong subscription and advertising growth for YouTube. Search continues to perform well although advertising revenues fell modestly short of expectations and the company announced a substantial ramp up in its capital expenditure plans in order to meet future growth opportunities in AI. Alphabet has vast cash resources, and a very cash generative business model so can easily afford to increase spending to exploit growth opportunities. Alphabet’s cloud business GCP is now profitable and had revenue of $9billion in the fourth quarter alone.

IBM’s quarterly results consolidated some of the major trends in its business which first attracted us to the shares. Since the relatively new management team of Arvind Krishna and James Kavanaugh relaunched IBM’s strategy in 2020, the proportion of software and consulting has grown from 50% of revenue to 75% in 2023. The major driver of top and bottom-line performance has been software, where Red Hat has been a transformative acquisition and is seeing accelerating growth, and consulting. The greater exposure to these areas alongside improved margins, better cost control and a cost reduction programme is leading to significantly improved cash flow. IBM has the technical expertise and the consultancy skills to cater to the burgeoning demand for AI and hybrid cloud amongst its customers and sales of Watson X doubled in the last quarter from the low hundreds of millions seen in Q3 and we believe the rerating of IBM has further to go.

In 2023 Eli Lilly and Novo Nordisk performed well on the back of breakthroughs in weight loss drugs. 2024 has started strongly for both stocks and once again Novo Nordisk produced strong results and guidance that pleased investors. Novo also announced a very significant increase in capital expenditure to fulfil expected demand for their obesity drug Wegovy in 2024 and beyond. We diversified our position in this sector of the market last year by adding Eli Lilly and taking some profits in Novo, which nevertheless remains a 3.5% position. We like the additional optionality provided by Lilly as it may also have a breakthrough product in Alzheimer’s disease, which is a massive market opportunity.

UPS shares fell 8% following their results which showed a disappointing guide for 2024 revenues and margins. 2023 was a tough year for UPS as it faced a possible strike by the powerful Teamsters union, which although a new contract was eventually completed, proved to be a significant business disruption at the same time as the economic environment was also slowing. We have great respect for CEO Carole Tome, but the company will need to meet quite ambitious second half targets in order to get back on track. UPS shares are trading back towards the bottom end of their trading range, and we are loathe to give up on them entirely having reduced our position last year.

We are maintaining a virtually fully invested stance at the current time, which reflects cautious optimism that the US economy will navigate a path of economic growth and lower inflation which will enable interest rates to fall as the year progresses. We believe that there will be similar moves in Europe and the UK, which hopefully will reduce the risk of recession in both those economies. Japanese stocks are being driven higher by a combination of loose monetary policy and improved corporate governance, which we believe will be a healthy combination for continued strong performance in 2024.

We are cautious of the economic outlook in China but do note that there are signs that the authorities are increasingly keen to adopt more supportive policies, so we are monitoring the situation closely but have not made any direct investment in these areas as yet.

Tim Gregory
Senior Fund Manager
Vermeer Investment Management