Nobody knows the repercussions of the economic actions taken against Russia.
It could unleash a chain of events leading up to the investment equivalent of a "Big Bang".
The problem with “Big Bangs” is that what "transpires on either side is unknowable from here." (Doomberg).
We have the rumblings of the first economic world war for a very long time. Nobody really knows the rules, and, as the modern global economy is so complex, collateral damage is unavoidable yet unpredictable.
However, we are becoming aware of some global economic repercussions (oil at more than $100 a barrel). Less clear is what tactics Russia might employ against the West. How this will change the world remains a mystery.
In the East, we have another serious COVID- lockdown situation in China.
25 million Shanghai residents have now been locked down for weeks.
*China's unwavering commitment to stamping out Covid by locking down big cities such as Shanghai threatens to deal a hefty shock to its vast economy, place more strain on global supply chains and further fuel inflation…
Meanwhile, port delays are getting worse, and air freight rates are soaring, putting even more pressure on global trade.*
This is happening at a time when Central Banks had already moved away from the policy playbook adhered to since the Global Financial Crisis. That is provide abundant liquidity to financial markets, no matter the cost.
Today, the biggest economic problem for Central Banks is inflation.
In a recent interview, the CEO of Heineken Beer told Financial Times:
“In my 24 years in the business I’ve never seen anything like it (inflation), not even close. It’s kind of off the charts.”
He added it’s “anybody’s guess” what the impact will be.
Markets like, and prefer, balance and a clear view into the future.
But things can be out-of-balance for a long time, hence the saying, “the market can remain irrational longer than you can remain solvent.”
Yet over time, the tendency of markets is to migrate towardsequilibrium, or long-term averages.
We have recently observed something of this nature.
For now, it would appear we are edging back toward greater balance. And while there are pockets of the market that will continue to perform reasonably well, I still believe the “average” stock is likely to face serious headwinds and challenges as this balancing act becomes more established.
What this means is that as investors we need to objectively scrutinize our portfolios and assess the outlook for companies againsttoday’s rapidly changing economic and market environment.
A key focus should be earnings power.
Remember, over the long term, share prices reflect earnings strength. But today, we are facing the worst inflation backdrop in 40 years. That will impact consumer and corporate spending and, by extension, company earnings.
Already we have compelling evidence of inflation-associated earnings erosion.
And we are about to enter the 1st quarter earnings reporting season for corporate America.
It’s no surprise that the FactSet earnings growth estimates for the S&P 500’s most recent quarter stands at 4.5%, the lowest growth rate since Q4 of 2020 (which was 3.8%).
Even mighty Amazon is adding a 5% surcharge for added fuel and inflation costs. This will be applied to 3rd party vendors who sell on Amazon. Will they just swallow this cost or pass it along to buyers?
No other event more consistently causes significant price movement in shares of a company than earnings. Expect heightened volatility in coming weeks.
We have enjoyed fabulous returns from equity markets, particularly last year coming out of the Covid pandemic. But it’s different now.
The tailwinds that underpinned those gains are fading.
This doesn’t mean all shares have to fall. But what it means is we must be far more deliberate about what’s in the portfolio today.
A useful exercise is to weed out fundamentally weaker companies and focus on the strong.
In investing, what is comfortable is rarely profitable. (Rob Arnott, founder of Research Affiliates)
Where could these stronger shares be?
Normally, investors can find refuge in the bond market. But with rates going up and inflation rampant, bond prices can be expected to fall, reducing the purchasing power of your money.
Today, many commentators and asset managers are describing the market as a “risk off” environment for equities because of fears recession brought on by high interest rates and inflation.
I prefer to say that I am seeking a risk-less environment.
Personally, I believe rate rises are well reflected by market prices, and investors are less concerned about interest rates and more worried about uncertainty.
In times of uncertainty, investors rotate away from higher risk assets and towards safe havens.
The “safer” shares out there are the mega caps of the world, and they have started to outperform. In contrast, he small caps have been under immense pressure since November last year.
So, why Mega Caps?
They tend to be titans of their industries. The have seen this movie and various alternative endings before and survived to tell the tale. Amongst these mammoths are possibly 90 of the largest companies in the world.
In the TEAM International Equity Fund, we own 35 of these companies in our portfolio. In other words, they represent 100% of the Fund.
They have “moats” or a defined and sustainable competitive advantage. They are “sticky” meaning they can pass through price increases without the risk of losing too many sales.
These companies have large positive free cashflows meaning they are less reliant on borrowing and potential interest payment increases.
Before interest rates started rising globally this was not a big deal. Borrowing costs were next to zero. That is no longer the case.
In the TEAM International Equity Fund, we currently own:
- Norsk Hydro
- AP Moller Maersk
- Walt Disney
Some of the clear-cut winners in a rising interest rate cycle are financials. Big banks clean up on net interest margin, the difference between the rates at which banks lend out at versus what they pay us for deposits, as rates go up.
In the TEAM International Equity Fund, we have in our top ten holdings, the global monster that is HSBC.
The recent strong rise in gold has been driven by inflation, inversion of yield curves causing concern of a global recession, excessive public and private debt, widening credit spreads, violent corrections in both equities and bonds, and a growing loss of confidence.
Historically, gold has been viewed as a hedge against inflation and currency devaluation.
Broader precious metals can be a great portfolio diversifier, particularly during times of market dislocation and stress.
Add to the above Putin's war, yet another reason to stoke investment demand for the yellow metal.
The upside is, despite the March 31, 2022, gold price of $1,937 exceeding the previous monthly average high of $1,825 set in August 2011 the price still lags the inflation-adjusted equivalent of $2,328 based on the August 2011 high. Gold has been treading water for 10 years.
There could be meaningful upside in gold and gold miners. At TEAM we particularly like the mining company shares.
Gold mining equities are now near a 35-year low vs. gold.
For the technicians, or chartists, gold shares have recently broken out to hit new 52-week highs.
The TEAM International Equity Funds holds Newmont, the world’s largest gold miner. It also mines for and produces copper, silver, zinc, and lead.
The power of dividends.
To write that inflation is hot right now is an understatement. My favorite M&S jelly dessert has gone up by 33% in the last month.
The recent U.S. Consumer Price Index (CPI) hit its highest level in 40 years (1981), with the Producer Price Index rose the most on record (11.2%).
But these numbers do not tell the full story. Over the years, governments and central banks have adjusted the way inflation is calculated. Calculating inflation statistics by applying the same methodology from the early 1980s, today’s rates in the US would be north of 15%.
For now, U.S. consumer confidence is unusually strong despiterising rates and inflation soaring. American consumers remain fairly optimistic. The Consumer Confidence Index rose to 107.2 in March, up from 105.7 in February.
Dividends frompaying stocks can at least partially offset inflation. Good working examples include companies that benefit from higher commodities prices (the TEAM International Equity Fund holds Exxon that currently generates a 4% annual dividend yield), or consumer staples companies that can effectively pass higher costs onto consumers (the TEAM International Equity Fund holds Unilever that currently generates a 4.2% annual dividend yield.
It should not be forgotten that, according to S&P Global, dividends account for 32% of the S&P 500’s total returns since 1926.
Fidelity says that during the 90 years from 1930 to 2020, dividends constituted nearly 40% of total returns.
The TEAM International Equity Fund portfolio has an average dividend yield of 2.3%.
A few hours before the tanks moved across the Ukraine border, a cyberattack against a satellite system separated thousands of Ukrainians from Internet access.
Elon Musk and his Star Link came to the rescue in a cameo role.
Recently it was identified that a ransomware group spend at least five months combing through a regional U.S. government agency’s files and system before attacking the affected computer.
“A robust, proactive, 24/7 defence-in-depth approach will help to prevent such an attack from taking hold and unfolding,” quoted Andrew Brandt, principal security researcher at Sophos.
If it wasn’t before, cybersecurity is now the paramount concern for all governments, companies and even us individuals. Not to add the military forces of the world.
The new “reality” is these cyber attacks can threaten power, water, communications, traffic, health care, supply chains, banking, and more.
Cyber security has become a non-discretionary expense or spend. We are less concerned with price and more with effectiveness. This is as inflation proof as it gets.
Even before the Russian invasion, according to consultantsGartner, worldwide spending on cybersecurity solutions has grown by around 9% per year since 2014.
Cybersecurity spending constituted just 3.5% of IT budgets in 2021.
In 2021, it grew by more than 12%, and is expected to grow another 12% in 2022 (before recent events).
We are in the foothills of a multi decade secular trend. We could be looking at annualized 10% plus growth in cybersecurity spending throughout the 2020’s and through the following decade.
One of the best and biggest plays on this theme is TEAM International Equity Fund top ten holding Microsoft.
CEO Satya Nadella recently disclosed that cybersecurity revenue exceeded $10 billion annually and that this business pillar is growing at 40% per year.
The second cyber security play the Fund owns is CrowdStrike. The shares could be classified as high risk because the valuation is expensive, and the shares have recently been volatile.
But CrowdStrike continues to report excellent numbers. The company’s fourth-quarter revenues of $431 million were up 63%. For the current quarter CrowdStrike is forecasting revenue between $458 million and $465.4 million, or year on year up 54%.
Those are impressive growth numbers in any instance. But when you’re talking about revenue, I think it is stunning.
The Semiconductor Decade
We have become almost completely reliant on these components.
Covid induced shutdowns demonstrated the critical nature of this industry. The supply shortages led to bottlenecks in the production of everything from cars to computers.
In many ways, our world is “built” on semiconductors and demand is set to rise over the coming decade, with semiconductor manufacturing and design companies benefiting.
McKinsey analysis based on a range of macroeconomic assumptions suggests the industry’s aggregate annual growth could average from 6 to 8 percent a year up to 2030.
The result? A $1 trillion dollar industry by the end of the decade, assuming average price increases of about 2 percent a year and a return to balanced supply and demand after current volatility.
The strongest-growing segment is likely to be automotive, followed by data-storage fueled by demand for servers to support applications such as AI and cloud computing.
Next, we have mobile devices or wireless. This will be the smartphone shift from lower-tier to mid-tier segments in emerging markets and backed by growth in 5G.
Lastly, we are again at peak fear
Many investors are paralyzed by fear. If these recession fears are overstated, then equities look set to enjoy a “melt up”.
I believe at some point there is a lot of money to be made in the stock market over the next 12 to 18 months.
Time in the market beats timing the market.