Vermeer Monthly – January 2023
10th January 2023
2022 was the worst year for the global equity market since 2008. The US market, which has led equities higher for so long, bore the brunt of market falls with the S&P 500 declining by 18.1% and the technology-based Nasdaq fell by as much as 32.5%. The Nasdaq also fell in every discreet quarter of 2022 for the first time in its history. Much of the fall in US markets was negated for Sterling based investors, thanks to the strength of the US Dollar against all major currencies, but notably the Pound and the Yen which both had very difficult years for very different reasons.
This time last year, we warned investors that we believed 2022 would be a more challenging year for equities. Excessively loose monetary policy led by the US Federal Reserve had enabled equities to pull forward future returns into 2021 and that 2022 would likely be much more difficult. We did not however, envisage just how far the Fed had got behind the curve on rates as inflation proved to be more stubborn at a higher rate than most commentators anticipated. Although the fall in the equity market was greater than we had anticipated, on a two-year basis the US equity market remains higher, after rising by around 29% in 2021.
Whilst we were correctly cautious on the outlook for markets and for most of the year had higher than normal levels of cash, performance was disappointing as we have a significantly lower level of exposure to the Dollar than the global benchmark, with the Fund having around 25% less exposure to US equities. Several of our growth-related positions that performed exceptionally well prior to 2022 had a tough year, even if their business models continued to prove very resilient. Notable amongst these names were Keyence in Japan, Davide Campari in Europe and Microsoft in the US.
The rally that pushed equities back up to 4,100 on the S&P by early December faded as investors took profits following a weaker than anticipated set of inflation figures that were followed by more hawkish than anticipated commentary the following day from the Chairman of the Federal Reserve. After the Fed increased interest rates by 50bps, following four successive 75bps hikes, Chairman Jerome Powell reminded investors that although inflation has started to come down, it is still way above their 2% target. Powell noted that it is therefore unlikely that rates will decline in 2023 unless a harsher than expected recession sets in and unemployment rises far quicker than has been the case in 2022, where job openings have remained very high. The latest job openings data indicated that openings remain well above the 10 million level, equating to there being 2% more job openings as a percentage to total jobs in the US than there was in 2019.
The Federal Reserve is now predicting that by the end of 2023, US interest rates will be above 5%
based on the Summary of Economic Projections by members of the FOMC. These projections forecast a year end rate of 5.1% with GDP growth in 2023 of just 0.5%. The recently released minutes from the December meeting highlighted that the Fed now believes it can be much more data dependent and will probably restrict rate rises to 25bps moves. However, it must be noted that as recently as September 2021, the Fed believed that interest rates would be just 1% and GDP growth would be over 3%! Whilst we acknowledge that COVID has created unprecedented challenges for the global economy and forecasting has been incredibly difficult, it does also highlight just how far behind the curve the Fed got in 2021 when it was convinced that inflationary pressures were transitory.
Supply chain disruption had a material impact on a multitude of companies in 2022. Nike and off-price retailer Burlington Stores were two particularly good examples of this. In late December, Nike issued quarterly results that handily beat expectations and suggested that the worst of supply chain disruptions, which had caused the company to issue a profit warning in the earlier part of the year, had materially eased. Burlington Stores shares have nearly doubled from their lows
of $109 set in late September. Investors have focused on the belief that the company is able to benefit from customers trading down to its off-price stores and that it will be able to benefit from the better-quality product that has become available as top retail brands do not want to be caught with excess inventory.
In December, Oracle reported results that beat expectations, showing continued growth in its cloud infrastructure business. Over 2022, Oracle shares battled back from a poor start to the year after announcing the $28billion acquisition of Cerner in late 2021. Chairman Larry Ellison recently commented positively on the Cerner integration, the opportunity that lies ahead in healthcare data and that “working together Cerner and Oracle have the capacity to transform healthcare delivery by providing medical professionals with better information – enabling them to make better treatment decisions resulting in better patient outcomes…..since the acquisition Cerner has contributed to Oracle’s growth – and Oracle has helped Cerner improve its technology.” Ellison also noted that “we are just beginning our mission to modernise healthcare information systems. Our goals are ambitious; fully automate trials to shorten the time it takes to redeliver lifesaving new drugs to patients…and provide public health professionals with an early warning system that locates and identifies new pathogens in time to prevent the next pandemic. The scale of this opportunity is unprecedented – and so is the responsibility that goes along with it.”
China finally reversed course on its COVID lockdown policy in the aftermath of its National Congress meeting in mid-October, sparking a large recovery from a very low base in equities with a significant exposure to the Chinese economy. Luxury goods retailer Moncler has seen its shares rally 30% from their mid-year lows, whilst Japanese cosmetics firm Shiseido has seen its share price rise from 4,900 yen to over 6,400 since early November. As well as benefitting from a reopening of both the Chinese and Japanese tourism markets, Shiseido management has been affecting a successful restructuring of the company after many years of underperformance.
In the final weeks of the year there was a major recovery in the beleaguered Yen as the Bank of Japan signalled the end of their yield curve control policy. BoJ Governor Kuroda announced that the ceiling on bond yields would be moved up from 0.25% to 0.50%, which completely wrong-footed investors who had been short the Yen and were not anticipating any change in policy until at least the change of Governor in April 2023. Although Japan is clearly not keen to import inflation and therefore does not wish the Yen to continue to be weak, it does not want to kill off its export led business, which plays such an important part in the economy. Policy decisions will be difficult for the incoming BoJ Governor, and it has also created an investment conundrum for Vermeer, as we have had a very globally oriented Japanese portfolio, which is a beneficiary of Chinese reopening, and it served us well for many years until 2022.
We closed the year with a high level of cash and remain cautious about the outlook for the equity market although potentially more optimistic that a more sustainable rally could ensue as the year progresses. After last year’s fall, valuations have really compressed down to more sensible levels, so we no longer see this as a risk to markets, although consensus estimates still have further to fall. Earnings may come under more pressure as the US economy slows and Europe remains weak. China’s reopening is unequivocally good news for the longer-term health of the global economy, but the process of normalisation will not be easy as we are already seeing with COVID cases rising rapidly in the country. We do not believe there will be a u-turn in policy but there could be further disruption to supply chains that may be a short-term negative influence on growth and inflation.
Senior Fund Manager
Vermeer Investment Management.