Month in review

Introduction

A short note on performance, across asset classes, factors, sectors and stocks. It is meant to be a convenient, highly summarised 3-4 page on things of interest over the past month.

See our flagship monthly strategy deck for a much more comprehensive analysis, available on request.

Asset classes

October was a strong month for risky assets, with International equities up over 6%, outperforming domestic (Australian) equities by a considerable margin.

Arguably, the RBA’s decision to not defend the yield curve target resulted in a significant degree of monetary tightening, at the margin, with both short and longer dated yields ratcheting higher as a result (and also appreciating the currency, and likely triggering the sell-off on the last day of the month).

Growth, as an investment style, outperformed quality and value. Whilst interest rates moved higher, the yield curve flattened, which aides secular growth stocks, that are sensitive to movements in longer dated interest rates.

The correlation of growth to changes in the interest rate is readily observable below, with the MSCI Australia growth basket (second section of the below graph) quite highly correlated to the AusBond composite returns (in contrast to Value, where the correlation turns negative).

Rates remain the primary threat to strong returns from this basket, moving forwards…

with high valuations a close second.

Nontheless, stocks have continued to do what they tend to do, which is climb the proverbial “wall of worry”.

More broadly, equity risk premia remain attractive, which is supportive to an ongoing allocation in line with one’s strategic objectives…

…and most asset classes remain on their expected frontier of risk vs reward (we tend to think in terms of Sharpe ratios, or risk adjusted returns, rather than in either on their own).

The exception has been fixed income, where higher rates are unambiguously bad, over the short run, as duration effects dominate…

…and the intra month repricing of rates pulled the belly of the curve higher, and the back end lower.

Overall, we still see credit risk premia as unattractive, at this stage of the cycle, with excess bond premia negative, after netting duration matched expected defaults from credit spreads.

The commodity complex continues to reflect the macroeconomic impacts of resurgent demand for goods, and COVID related supply side constraints that have curtailed production.

In lumber, iron ore and, over the past month, coal, these demand and supply mismatches are being slowly ironed out, as we suspect they will for most commodities.

Sector (Australian shares)

Sectorally, energy stocks had a weak month, with some of the more acute price dislocations in coal and natural gas abating, as a mix of policy interventions from both China and Russia resulted in a modest easing of some supply side constraints. Additionally, high prices are often the cure for high prices through demand destruction, some of which we surely saw.

Resource stocks continue to suffer from the negative spill over effects resulting from the Evergrande/China-property contagion story.

To our minds, growth stocks, typically found in consumer discretionary (DMP, BRG, JBH), Info tech (WTC, XRO) and health (RMD, COH) are all trading at eye-watering multiples, which we believe will be very difficult to sustain.

Stock (Australian shares)

At the stock level, a more heterogenous mix of idiosyncratic stock effects diluted the broader macro story. WHC is assuredly suffering from the decline in Zhengzhou thermal coal prices, however WHC doesn’t sell coal to that market, and Newcastle coal prices are still quite strong. Rather the story is developing mines that the market doesn’t seem to value, rather than just buying back shares.

EML has been caught up in issues with the regulator, as have CWN and the Star (noting that CWN has in fact received a modest reprieve, by being able to operate for another two years, rather than an immediate cancelation and transfer of the licence).

Aurizon’s management, somewhat similarly to WHC’s, is engaging in business development at a price and deal structure that has not enthralled the market, and has moderately stressed the balance sheet to do so.

At the other end, the outperformers are marked by commodity stocks where deficits are forecasted to widen, such as the lithium, cobalt, nickel plays, and the platforms (Netwealth, Hub) whose robust inflows stand in stark contrast to the fund managers, where outflows continue. After a very difficult few months, the fund managers are now looking like good value, to our minds.

Steel stocks, overall, have done well given China’s efforts to reduce emissions mean a lower supply of steel (and hence why iron ore prices are down, yet hot rolled steel prices are up), as well as the unintended side effects of higher energy prices, which lead to a reduction in the production (and hence supply) of energy intensive products (like steel and aluminium).

Rounding out the list, the engineering firms enjoyed a solid bounce. Stocks like Monadelphous and Worley have seen multi-year revenue declines on the back of lower oil and gas projects (with almost no new greenfield capex development). As reserves deplete, and energy prices remain high, the incentive (and need) to lift capex has resulted in a modestly higher market appetite for developers and constructors.