Vermeer Monthly – June 2023
2nd June 2023
Global equities were broadly stable at an index level in May, rising modestly in Sterling terms. Markets over the month were totally dominated by the performance of the tech heavy Nasdaq which rose nearly 6% and was completely propelled by the artificial intelligence (AI) trade that has been dominating recent headlines with positive news flow accelerating in May after the astonishing results posted by chipmaker Nvidia. This helped the S&P 500 post a modest gain and disguised the fact that most of the market was lower over May and indeed a number of sectors really struggled.
As the year has progressed, the market has become more narrowly focussed to a handful of stocks that have completely dominated performance. Whilst Nvidia is at the forefront of the AI boom and has more than doubled in share price terms this year and crossed the $1trillion market cap level in intraday trading at the end of the month, the returns generated by Amazon, Alphabet, Apple, Meta, Microsoft and Tesla have also been seriously impressive. Of these companies, we own all but Meta and Tesla but we do also own ASML and Oracle, one of the largest positions in the Fund, which both have an AI angle and has aided year to date performance.
In the US, negotiations over raising the debt ceiling rumbled throughout May with the usual brinksmanship before a deal was finally struck. Whilst this is very important economically it should not propel markets higher as there was never any fear of failure priced into equity markets. The US economy has clearly slowed as the Federal Reserve hoped it would but with unemployment still at very low levels, inflation has remained stickier than anticipated and once again expectations for interest rate cuts have been pushed out. Indeed, many members of the FOMC at the Fed still believe that rates should be going higher. We do not agree with this view, believing instead that having raised rates so many times so quickly, the Fed should now adopt a “wait and see” approach and see how the economy develops over the coming months. However, we also don’t expect rates to be cut any time soon unless further problems emerge in the banking sector or unemployment statistics deteriorate very quickly.
In China, the reopening of the economy appears to be stuttering, raising concerns about future growth rates and the continued weakness of the property market. This has led to questions about the extent to which China’s economy will recover in the post pandemic phase. The Chinese Government has set a target growth rate for the year of 5% and its longer term targets out as far as 2035 imply that it is comfortable with this as the new level of sustainable growth for the economy. However, investors have been disappointed that there has not been a greater resumption of travel growth as yet and luxury goods stocks that have enjoyed a really strong start to the year have now given back some of their gains.
In Japan the Nikkei 225 index has performed very well this year in local currency but a significant amount of these gains have been eradicated by the renewed weakness of the Yen. New Bank of Japan Governor Kazuo Ueda has steadfastly maintained a no change to policy attitude, for the time being at least, removing expectations that there will be a further shift in yield curve management. A shift had been highly anticipated following the move late last year by previous Governor Haruhiko Kuroda to move the cap on yields up by 25bps to half of one percent. Despite the significant weakness of the Yen, Japanese stocks have posted solid gains this year and we believe that one of the major factors behind this is a significant improvement in shareholder returns that has been sparked by pressure from the Tokyo Stock Exchange, which earlier this year mandated companies that have been consistently trading below book value to announce improvement plans. Recent results show early signs that this has been effective as buybacks and dividend growth have notably improved. For example, Toyota announced a move to a more western style progressive dividend policy while Olympus and Sony declared new share buybacks. Expectations of an improvement in shareholder returns is one of the key reasons that we have long maintained an overweight position in Japanese equities.
Earlier we mentioned the astonishing results delivered by Nvidia which were powered by the early adoption of AI tools that is accelerating demand for its GPU chips. Effectively Nvidia has been anticipating this shift in computing for some time so had positioned itself to meet the acceleration in demand when it occurred. Nvidia shares rose 25% on the day after they produced results but in effect this represented a derating of the shares as earnings forecasts have been upgraded by such a large amount to reflect the shift in its business model. We have held a position in Nvidia for a number of years and it has been a real rollercoaster, performing well in 2021 and disastrously in 2022 before this year’s incredible, but in our view totally justifiable recovery. However, we are mindful that a bubble of expectations is now inflating in AI and are reviewing all of our positions that have recently been material beneficiaries of the significant re-rating of just a handful of companies that have delivered virtually all of the returns for global markets this year.
Oracle shares have gained over 30% this year as the market has identified the company as a potential AI winner. There is no doubt that it should benefit from its partnership with Nvidia, which was formed in 2022 to bring together Oracle Cloud Infrastructure with Nvidia AI software and services to help customers solve business challenges with accelerated computing and AI. Nvidia selected OCI as the first hyperscale cloud provider to offer Nvidia DGX Cloud and AI computing services at massive scale. We believe Oracle’s position in Enterprise data and its recent acquisition of healthcare data provider Cerner will prove highly valuable in enabling it to be at the forefront of growth in the use of AI. Despite seeing a multiple re-rating this year, Oracle remains relatively better value that a lot of businesses caught up in the AI trade, with the stock trading on around 19x next year’s earnings.
Recent retail company results have been mixed and both Target and Burlington Stores have seen their share prices weaken after a strong start to the year. The consumer spending environment is proving to be challenging and guidance by both companies for the upcoming quarter was very cautious although they both left full year expectations unchanged. It is likely that conditions will remain tough in the coming quarters if, as we expect, interest rates do not fall. We are reviewing our position in Target but do believe that Burlington offers a long term proposition of store expansion and margin and cash flow growth that could be a very powerful driver of the stock price in the long term.
We reluctantly closed out our position in Befesa this month. Whilst the company is executing well in a very tough operating environment, we felt that the short term macro headwinds facing the company are likely to continue and despite the company trying to mitigate as much impact of this on the business as they can, a lot of these factors are out of their control and so will likely continue to pressure earnings. We will continue to monitor the stock as we still believe it is very well positioned to benefit from secular tailwinds driven by climate policy.
The market has become very narrowly focussed, with really only the AI trade working for investors as they scramble to get positions in the stocks they see as the long term winners. Sustained high interest rates and quantitative tightening continue to constrain liquidity in the market and this is hindering many other sectors. We are maintaining a reasonably high level of cash as markets remain uncertain and when so much performance has been crowded into such a small number of stocks, this inevitably creates a degree of caution in our thinking.
Senior Fund Manager
Vermeer Investment Management