Global Equities - Market Update - August 2020

01 September 2020

This report has been prepared by Northcape Capital, the underlying investment manager for the Warakirri Ethical Global Equities Fund.

Market Review

MSCI World continued its recovery during August ending the month +6.7%, surpassing its pre-COVID peak from February. The weak USD/strong AUD however meant the benchmark in AUD was only +3.2% for the month.  Consumer Discretionary (with Tesla and Amazon significant contributors) and Tech were the top performing sectors whilst Utilities was the only sector down for the month. Energy was the second worst performing sector despite the oil price being ~5% higher for the month. Growth also continued to outperform Value but interestingly Momentum was a sizeable negative contributor for the month.

August saw the tail end of earnings season, which continued to show US companies generally exceeding expectations and hence earnings being revised up slightly (albeit to a lesser extent than in July) whereas Europe and Asia continued to be revised down slightly. Forecasts for next year had even more muted revisions as companies continued to shy away from guidance.

Macro news flow was relatively light and low impacting with the exception of Fed Chair Powell’s flagging that he is prepared to let inflation overshoot its target to make up for historic undershooting, effectively signaling that low rates are here to stay for the foreseeable future. In a market that was seasonally quiet in terms of news flow and trading volumes in the final weeks of summer, it was the strong share price rallies in certain tech, growth & recovery stocks, in many cases unassociated with earnings or other fundamental news flow and more to do with stock splits (for Apple and Tesla anyway) that stole the limelight.

For the month we saw for example, Tesla +74%, Salesforce.com +40%, Apple +22%, FedEx +30% and RCL +41%. Not owning these ‘high-flyer’ stocks hurt our performance during the month but was somewhat offset by our holding in Nvidia +26%. Whilst the months underperformance was disappointing, we remain comfortable with the fundamentals of the stocks we own and prefer not to chase the hype in those we don’t. Putting this into context we thought it worth highlighting some interesting observations:

• Apple’s market cap is bigger than the UK’s FTSE100 and close to the market cap of all German stocks. Its weight in the S&P also surpassed that of Consumer Staples during the month.
• The market cap added by Apple just since reporting and announcing its stock split at the end of July is equal to the combined market cap for the bottom 77 stocks in the SPX.
• Looking at wealth creation from Amazon, Jeff Bezos is now Warren Buffett richer than Bill Gates.
• Elon Musk has founded / co-founded companies that are now worth more than 500% of the total combined accumulated revenue of all of them. And none of them has ever had a profitable full year, yet.
• Tesla ended the month as the 7th largest company in the world and closed out the month with a market cap >19x its sales. It added ~$200bn in market cap during the month, equivalent to 5 Ferrari’s or Fiat, Peugeot, Renault, BMW, Daimler and VW combined.
• The CBOE three-month equity put/call ratio hit lows not seen in almost twenty years.

The above, combined with reports of significant increases in retail trading activity over recent months and record low short interest contrasts saw the VIX rising from its post COVID lows of 21.4 to 26.4 during August and a step up in longer dated bond yields. Perhaps the rise in inflation expectations helps with reconciliation and is worth watching in our view.

Other areas of good news are decreasing daily COVID-19 cases in the US (albeit Europe has been increasing with second waves in France and Spain in particular), reflected in global activity trackers continuing to slowly improve. Housing data has also been positive in both the US and Europe with US July existing home sales +24.7%, the number of new sales agreed per agent in the UK in August 76% above their 5-year average and the German House Price Index +1.2% MoM in August and +6.3% YTD.

Portfolio Review

The portfolio suffered from a disappointing set of Q3 earnings from Becton Dickinson and subsequent competitor news flow impacting its COIVD antigen test, following on from very strong share price performance in July. Becton is one of our bigger positions and as a large and highly diversified medical consumable play should be relatively defensive. Unfortunately, their operations were more heavily impacted by COVID than expected (FX neutral revenue growth -9.4% in Q3 but excluding COVID would have been +4.5%) and full year guidance was lowered 4.5%.

Shortly after Becton reported earnings, Abbot Labs then announced a competing rapid point of care antigen test for COVID-19. In addition to ramping to much greater test capacity (50m tests per month vs Becton at 12m) and not requiring a reader (such as Becton’s Veritor reader) importantly Abbot’s test is to be priced at a much lower point, $5 versus Becton’s $20 per test. Whilst negative we see this news more as a slight reduction in upside and note street estimates for Becton have been unchanged post the announcement, with analysts noting the company remained comfortable with their product. We remain confident in the post COVID 5%+ topline and 10%+ bottom line growth story and think the stock looks compelling on <20x 1 year forward PE.

Unicharm shares also sold off after the company reported Q2 earnings. Revenue was slightly weak, but margins were strong and unchanged EPS guidance despite this seemed to be the primary driver after the stock also experienced strong share price performance in July. Again, the long-term story of profitable growth via the company’s strong positioning for increased personal care penetration in Asia remains intact.

The other main detractors to our performance Electronic Arts, American Tower and Marsh McLennan who all reported solid earnings late July. American Tower is also sensitive to rising US bond yields.

Nvidia, as previously mentioned was one of the ‘high flyer’ growth stocks and hence our biggest contributor to performance this month. The share price move was also in part due its fundamentally strong Q2 earnings and (Q3 EPS) outlook which were both ~10% ahead of sell side analyst estimates. Q2 revenue was +50% including its acquisition of Mellanox but still +30% excluding it and gross margins continue to improve, showing earnings momentum is on its side despite the all-time high 1 year forward P/E now >50x.

Techtronic was also a beneficiary of very strong earnings as it benefits from a very strong product franchise and desire for home improvement. Its revenue was +13% YoY for H1 and EBIT +16% and the shares rose 10.9% on the day they reported. Whilst the argument can be made for a deceleration in COVID driven demand we believe the company’s strong product IP in the growing rechargeable battery tool category, launch of its new MX Fuel range (heavy duty pro tools) later this year and very strong management execution should allow Techtronic to continue to produce double digit revenue growth over the medium term.

Rightmove was also up strongly (+9.1%) the day it reported. Whilst the numbers were roughly in line with expectations and heavily impacted by discounts provided to real estate agents to help them through the COVID lockdown in the UK, the commentary on the UK housing market outlook and Rightmove’s strong competitive positioning was all positive.

Whilst there was no specific news for Informa it benefitted from low expectations after weak performance in July and its position as a re-opening beneficiary trading on ~15x 1 year forward PE.

The Warakirri Global Equities Fund is long only, low turnover, concentrated and benchmark unaware. As such it will typically hold up to 40 stocks. These stocks will come from a concentrated Approved List based on Northcape’s research of around 60-75 selected stocks from global developed markets which comprise of resilient companies with enduring quality characteristics that are typically within attractive industries.