Saxo Morningstar High Dividend EUR Q3 2022 commentary

Market overview

At a glance

• For the third quarter in a row, stocks and bonds have fallen.\
• Central banks remain serious about bringing down inflation, causing investor sentiment to deteriorate. 
• Fears of a global recession continue, with the USD reaching new highs. 
• On a positive note, valuations of stocks and bonds continue to improve, sowing the seeds for future returns.

Important perspective

Stocks have now fallen for three quarters in a row, while bonds have equally headed south. Nine of the 10 major equity sectors also fell in the third quarter of 2022, highlighting the non-discriminatory nature of the sell-off. Exuberance has given way to pessimism, driven by weakening corporate profits, concerns about slowing consumer demand, liquidity tightening and the potential for recession as the central banks redoubled their commitment to bring inflation down.

Inflation has remained stubbornly high, with core inflation becoming a contributing driver. The ongoing war in Ukraine has also continued to wreak havoc on global supply chains and energy supplies. China, which represents close to 19 per cent of global gross domestic product, is struggling with a sharp economic slowdown. Earnings warnings from high-profile global companies, such as FedEx among others, have spooked investors. Even the defensive sectors have sold off, including healthcare and consumer staples. One key issue is that the market is anticipating a decline in corporate earnings on the horizon—the magnitude and duration of which are hard to know in advance.

Turning to fixed income, both government and corporate bonds have felt the pain, with broad-based losses across the risk spectrum. The most aggressive moves continue to come from long-duration bonds, which carry a higher sensitivity to interest rate changes. The silver lining is that the yields on most fixed-income assets are much higher.

The USD has had a remarkable run, reaching new highs against almost every other major currency, while some notable deterioration occurred in Europe—especially the GBP. This flight to safety toward the USD can exacerbate issues for global companies as well as emerging markets that borrow in that currency.    

Portfolio performance (net of fees)

Top 10 portfolio holdings (as of 30/09/2022)

Top performers:

• Cheniere Energy Partners LP Cheniere Energy Partners is the direct owner of the Sabine Pass LNG terminals as well as regasification facilities. It also owns the Creole Trail Pipeline, which connects the terminal to third-party gas suppliers. Cheniere Partners shares in the marketing fees generated by Cheniere Marketing from Sabine Pass marketed gas volumes.
  
  Cheniere is expected to have about 45 million metric tons per year LNG capacity on line in 2022 and 60 million metric tons in 2026. Volatility in the market should provide ample opportunities for Cheniere to take advantage of wide LNG differentials at different hubs around the world, given its access to growing US supply and the very stable cash flows brought in by its Sabine Pass and Corpus Christi trains.
  
  
• Genuine Parts Co Genuine Parts sells automotive parts (about two-thirds of net sales) and industrial components. The company sells vehicle parts to commercial and retail customers through roughly 9,700 stores worldwide, most of which are independently owned. Its industrial unit, primarily operating under the Motion Industries banner in the United States, supplies bearings, power transmission, industrial automation, hydraulic and pneumatic components to maintenance, repair and OEM clients.
  
  Genuine Parts benefits from industry dynamics favouring its scale-enabled service levels. Aftermarket auto-part retailers serve DIY and professional clients. The faster-growing latter category (more than 80 percent of segment sales for Genuine Parts) depends on high levels of part availability and rapid delivery to turn repair bays quickly. Both categories had benefitted from rising miles driven and average vehicle age, along with low unemployment, but have shown resilience in past recessions.
  
  
• Huntington Bancshares Inc Established in 1866, The Huntington National Bank is a commercial banking institution, headquartered in Columbus, Ohio. The bank provides a range of personal, commercial, and small business solutions that include savings and checking accounts, mortgage banking, personal and commercial lending, equipment leasing, insurance, private banking, treasury management, and investment banking among others. Huntington is a full-service bank primarily operating across an eight-state banking franchise of Ohio, Illinois, Indiana, Kentucky, Michigan, Pennsylvania, West Virginia and Wisconsin. Huntington Bancshares operates as the holding company for the bank.
  
  
• Roche Holding AG Roche is a Swiss biopharmaceutical and diagnostic company. The firm's best-selling pharmaceutical products include a variety of oncology therapies from acquired partner Genentech, and its diagnostics group was bolstered by the acquisition of Ventana in 2008. Oncology products account for 50 percent of pharmaceutical sales, and centralised and point-of-care diagnostics for more than half of diagnostic-related sales.
  
  
• Magellan Midstream Partners LP Magellan Midstream Partners is a master limited partnership that operates pipelines and storage terminals in the central and eastern United States. Its assets transport, store, and distribute refined petroleum products and crude and earn a fee-based stream of cash flows. Assets include the country's longest petroleum pipeline network and several crude oil pipelines. Refined products make about 70 per cent of its operating margin, with the remainder mainly crude-oil pipelines.
  
  Magellan’s second-quarter results were solid, as the partnership held its full-year guidance of USD 1.09 billion in distributable cash flow unchanged. Broadly, lower oil and gas prices and higher forecast expenses in the second half of the year will offset better-than-expected crude oil earnings so far in 2022 due to higher volumes. With inflationary expectations very high, Magellan could see a potential 10-15 percent increase in its indexed rates in 2023. 

Worst performers:

• Sanofi SA Sanofi develops and markets drugs with a concentration in oncology, immunology, cardiovascular disease, diabetes and vaccines. The company offers a diverse array of drugs with its highest revenue generator, Dupixent, representing just over 10 percent of total sales, but profits are shared with Regeneron. About 30 percent of total revenue comes from the United States and 25 percent from Europe. Emerging markets represent the majority of the remainder of revenue.
  
  
• Verizon Communications Inc Verizon is primarily a wireless business. It serves about 93 million post-paid and 23 million prepaid phone customers (following the acquisition of Tracfone) via its nationwide network, making it the largest US wireless carrier. Fixed-line telecom operations include local networks in the northeast, which reach about 25 million homes and businesses, and nationwide enterprise services.
  
  Verizon is primarily focused on the wireless business. The firm holds roughly 40 percent of the US post-paid phone market. Leading scale enables Verizon to generate the highest margins and returns on capital in the industry, despite heavy investment. Verizon has undertaken a major fibre expansion project in recent years to extend capacity into more locations around the US. This approach will allow Verizon to maintain a strong network position in the traditional wireless business while also serving new markets such as fixed-wireless broadband and edge computing. These offerings will remain small but still deliver incremental revenue to lift returns on network investments.
  
  
• AT&T Inc The wireless business contributes about two-thirds of AT&T's revenue following the spinoff of WarnerMedia. The firm is the third-largest US wireless carrier. AT&T also has a sizable presence in Mexico, serving 21 million customers, but this business only accounts for 2 percent of revenue. 
  
  Aggressively extending fibre and 5G coverage to more locations builds on its core assets—its existing network and customer relationships—and should allow AT&T to gradually expand its share of telecom spending. AT&T and Dish recently signed a 10-year wholesale agreement that should allow AT&T to participate in Dish's growth. AT&T also benefits from its ownership of deep network infrastructure across much of the US and its ability to provide a range of telecom services. AT&T expects to reach around 30 million total customer locations with fibre by 2025, covering about half its existing fixed-line footprint, making it the third-largest high-quality fixed-line network in the US. 
  
  
• GSK PLC In the pharmaceutical industry, GSK ranks as one of the largest firms by total sales. The company wields its might across several therapeutic classes, including respiratory, cancer and antiviral, as well as vaccines. GSK uses joint ventures to gain additional scale in certain markets like HIV.
  
  
• Intel Corp Intel is the world's largest logic chipmaker. It designs and manufactures microprocessors for the global personal computer and data centre markets. Intel pioneered the x86 architecture for microprocessors. While Intel's server processor business has benefitted from the shift to the cloud, the firm has also been expanding into new adjacencies as the personal computer market has stagnated. These include areas such as the Internet of Things, artificial intelligence and automotive. Intel has been active on the merger and acquisitions front, acquiring Altera, Mobileye and Habana Labs in order to bolster these efforts in non-PC arenas.
  
  On August 23, Intel announced a new co-investment programme with Brookfield Asset Management to help fund Intel’s manufacturing expansion in Arizona. Management has been stressing it expects to offset part of the hefty capital expenditure outlays required for its internal and foundry manufacturing aspirations via smart capital offsets, or government subsidies, private investment programmes and foundry customer prepayments. 
  
  

Outlook

With so few places to hide, it’s understandable that investors are feeling very nervous. However, for those still investing, the outlook is improving as lower prices imply higher returns. Valuations, on almost every measure, continue to improve. In such environments, it’s helpful to think about investing as a little like farming; there are times when we are harvesting previous gains and times when we are sowing the seeds for future returns. As prices fall, we’re moving into sowing season. 

It remains important to not be assumptive of where the market, or the economy, goes from here. As it stands, equity prices are in a similar place to where they were in the last quarter of 2020, so investors are likely to be further along in their journey toward their financial goals than they expected to be when they started.

However, for valuation-driven investors (who aim to buy assets at discounts to what they’re worth), periods like this can result in tremendous opportunities. The uncertainty that dominates the headlines today can lead investors to cut and run, leaving upsides to those willing to invest and stay the course for the long run.