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Saxo Morningstar Moat USD Q4 2022 commentary

SaxoSelect Commentaries
Instruments tradedStocks
Asset classesGlobal equities (excluding emerging markets)
Investment style High quality stocks that are priced at a discount to fair value
Dividend yield
1.69%
Quarterly return9.45% (net of fees)
Annualised volatility (since inception)24%

Market overview

Quarter at a glance

  • Stocks and bonds recovered in a volatile quarter, although most markets remain well below their peaks. 
  • Fears of a global recession have taken centre stage, with corporate earnings showing vulnerabilities. 
  • There are some signs inflation may have peaked, with the year-on-year inflation rate slowing down.

Year at a glance

  • Stocks and bonds both fell considerably over the year, despite the recovery in the last quarter. On many measures, it was one of the most challenging environments for investors.
  • Central banks became increasingly serious about bringing down inflation, causing investor sentiment to deteriorate. 
  • The exception of the year was energy-related assets, which had one of its best years on record.  
  • USD strength has been a feature of 2022, rising to its highest levels in two decades at one point in the year. 
  • On a positive note, valuations of stocks and bonds improved meaningfully, sowing the seeds for future returns. 

Important perspective

2022 will go down as a very difficult one for investors, following several years of market strength. The S&P 500 lost 18.1 percent for the year, its biggest calendar-year loss since 2008. This came despite stocks and bonds both having a great fourth quarter, making up for the losses generated earlier in the year. 

Among the challenges noted were inflation, rising interest rates and geopolitical risk. In the fourth quarter, inflation showed signs of peaking, which may allow central banks to reduce their aggressive interest rate increases. The US Federal Reserve (along with many other central banks) raised interest rates seven times in 2022, but the one in December was smaller than the previous increases (50 basis points), perhaps offering a small sign the worst of inflation is behind us.

Among equities, the sectors that suffered the most throughout the year were: technology, consumer discretionary, and communications services. Value stocks benefited from a revitalised energy sector and a collection of defensive stocks in the healthcare, consumer staples and utilities sectors. In contrast to growth stocks, the year-end left the Morningstar US Value index down just 0.7 percent in 2022. Emerging markets suffered from Russian stocks becoming un-investable, along with weakness in the Chinese market as well as in South Korea. European stocks also suffered amid the Russia-Ukraine war. 

While bonds have been a key diversifier for investors during many stock market downturns, that wasn’t the case in 2022. Rising interest rates caused bond prices to fall. On many measures, bonds had their worst year in decades, with much of the damage attributed to higher interest rates. That said, the fourth quarter saw a meaningful comeback for bonds, especially at the riskier end, including high yield and emerging-markets bonds.

Portfolio performance (net of fees)

October
3.26%
November
9.93%
December
-3.58%
Since inception (December 2016)
61%

Top 10 portfolio holdings (as of 31 December 2022)

NameWeight (%)
Just Eat Takeaway.com NV4.64
Imperial Brands PLC4.43
Lloyds Banking Group PLC4.32
Grifols SA4.08
BorgWarner Inc4.04
Compass Minerals International Inc4.01
Tencent Holdings Ltd ADR3.91
Hongkong Land Holdings Ltd3.85
Adient PLC3.76
Leonardo SpA Az nom Post raggruppamento3.55

Top performers

ABN AMRO Bank NV 

  • ABN AMRO Bank is an international commercial bank established in 1991 and headquartered in Amsterdam, Netherlands. The bank offers a full range of services to retail, private and commercial clients through omnichannel distribution, including advanced mobile applications and internet banking. ABN AMRO's investment banking division offers services in the areas of mergers and acquisitions advisory, corporate advisory, portfolio management, capital structuring and advisory, commercial finance, cash and liquidity management, debt, equity capital markets, acquisition financing, leveraged and management buy-outs, recapitalisation, public-private agreements, senior debt instruments, and equity investments.

Just Eat Takeaway.com NV

  • Just Eat Takeaway operates an online marketplace that connects restaurants with users in Europe and North America. The company operates mainly as an order-only marketplace, although it also offers last-mile delivery services. The company is the result of the merger of Just Eat Plc and Takeaway.com NV in early 2020. Excluding the US after its recent acquisition of Grubhub, the company's largest geographical presence by revenue is in the UK, Germany, Canada and the Netherlands.
  • On 3 November, the New York City Council introduced a bill that will exempt food delivery companies from the cap on fees it charges to a restaurant. Restaurants that are willing to pay more for additional services such as advertising, search engine optimisation and credit card processing will be allowed to do so, in which case the final take rate for the food delivery platform could be similar to the one they are charging restaurants in states without a permanent fee cap. Although the timing of implementation of this amendment is uncertain, Just Eat Takeaway, through Grubhub, is impacted the most, given its significant exposure and relative size in the area. 

Grifols SA

  • As a vertically integrated plasma derivative producer, Spain-based Grifols collects plasma and then manufactures and sells plasma-derived products globally. By acquiring Talecris in 2011, Grifols dramatically expanded its plasma-derived product portfolio, and the firm's biopharma business contributed 77 percent of sales in 2021. Grifols also has smaller segments including diagnostics and bio supplies. Diagnostics is roughly 10 percent of revenue (following the Biotest acquisition).
  • Grifols reported third-quarter revenue growth of 37 percent, benefiting from both the incorporation of the recent Biotest acquisition as well as foreign exchange tailwinds. Grifols is still facing higher costs from donor compensation and labour cost inflation, and Grifols' long inventory holding period means that improvements will take time to become apparent on the income statement. The assumption is that the market is underappreciating Grifols' ability to recover from COVID-19-related headwinds and financial leverage. 

BorgWarner Inc

  • BorgWarner is a Tier I auto-parts supplier with four operating segments. The air management group makes turbochargers, e-boosters, e-turbos, timing systems, emissions systems and more. The e-propulsion and drivetrain group produces e-motors, power electronics, automatic transmission components and torque management products. The two remaining operating segments are the eponymous fuel injector and aftermarket groups.

  • BorgWarner intends to spin off its fuel systems and aftermarket businesses to shareholders by the end of 2023. Management expects the spinoff to be tax-free for US federal income tax purposes. The firm did not provide specifics about NewCo capitalisation, only saying the spinoff would have moderate leverage and solid liquidity. Management also said NewCo would have a double-digit operating margin profile enabling “solid free cash flow”. While the spinoff is contingent on the board of directors’ approval, US Securities and Exchange Commission filing, receipt of a tax opinion, and certain regulatory approvals among others, the transaction is very likely to be completed. By announcing a spinoff now with completion expected in about a year, the timing places the transaction at a point when auto sector headwinds probably lessen and market valuation may potentially improve.

Tencent Holdings Ltd ADR

  • Tencent is arguably the most influential internet firm in China as one can hardly go by a day without using its products. Tencent is the world's largest video game vendor and owns the world's top-grossing mobile game. Tencent also runs China's largest social media super app, WeChat. Tencent is also among the world's largest venture capital and investment corporations. The firm is now one of the largest shareholders in leading tech companies like Meituan, JD, DiDi, Snap, PDD, Kuaishou, Epic Games and more.

  • The latest regulatory announcement from the US should help add investor confidence in Chinese ADRs. The Public Company Accounting Oversight Board in the US said on 15 December that it had gained full access to inspect and investigate firms in China. Before this, investors feared the Holding Foreign Companies Accountable Act could force hundreds of Chinese companies listed on US exchanges to delist starting as early as 2023. The news should support recent outperformance by Chinese equities following moves to relax COVID-19 testing and quarantine policies in China. Although volatility may persist as COVID-19 cases increase in China, the combined news presents a floor in terms of risk premium to China equities. While Chinese stocks have rebounded off lows, ADRs such as NetEase, Alibaba, Yum China and JD.com are still seeing attractive upsides. 

Worst performers:

RingCentral Inc 

  • RingCentral is a unified communications as a service (UCaaS) provider. Its software helps users communicate and collaborate via voice, video, and messaging across all device types and all from one platform. RingCentral helps customers modernise and move from legacy on-premises systems to modern, cloud-based systems. Beyond its core RingCentral MVP solution, RingCentral also offers a cloud-based contact centre solution, a standalone video meetings solution, and webinars.
  • Despite being one of the leading providers of UCaaS, RingCentral delivered uneven returns and the intensifying competition observed in the market may limit growth and profitability. 

  • The importance of core communication, combined with the firm’s leadership position, provides RingCentral with a significant growth opportunity which is to be observed going forward. 

Lyft Inc Class A

  • Lyft is the second-largest ride-sharing service provider in the US, connecting riders and drivers over the Lyft app. Lyft recently entered the Canadian market in an effort to expand its market outside the US. Incorporated in 2013, Lyft offers a variety of rides via private vehicles, including traditional private rides, shared rides and luxury ones. Besides ride-share, Lyft also has entered the bike- and scooter-share market to bring multimodal transportation options to users.

  • While Lyft’s mixed third-quarter results and fourth-quarter guidance were disappointing, there is still strength in the firm’s network effect which has driven growth in rider monetisation. In addition, Lyft’s latest cost-cutting measures helped with the profitability. The firm is also reducing its marketing expenses and lowering real estate costs by at least 50 percent. Lyft expects these actions to save the firm around USD 350 million. However, there is a lowered revenue growth assumption for this year through 2026 given the ongoing uncertainty regarding the macro environment. 

Palantir Technologies Inc 

  • Palantir Technologies provides organisations with solutions to manage large disparate data sets in an attempt to gain insight and drive operational outcomes. Founded in 2003, Palantir released its Gotham software platform in 2008, which focuses on the government intelligence and defence sectors. Palantir expanded into various commercial markets with its Foundry software platform in 2016 with the intent of becoming the data operating system for companies and industries. 

  • Despite the near-term challenges posed by harsh macroeconomic conditions, Palantir has long-term growth potential. There is an expectation that the firm’s top line will become more predictable due to a continued diversification of the firm’s revenue as commercial sales increase as a percentage of total sales. Shares were hit hard upon the release, down around 7 percent after markets opened. Palantir’s customer count grew 66 percent year over year to 337, with commercial customer additions being key in driving that number forward. An expansion of Palantir’s commercial customer base is essential for the firm’s long-term growth as it lessens the impact of the uncertain timing of government contracts and makes Palantir’s top line less volatile.

Altice USA Inc Class A

  • Altice Europe acquired privately held US cable company Suddenlink in 2015 and Cablevision in 2016. Suddenlink's networks provided television, internet access and phone services to roughly 3.5 million US homes and businesses located primarily in smaller markets, with major clusters in Texas, West Virginia, Idaho, Arizona and Louisiana. Cablevision provided comparable services to about 5.5 million homes and business in the New York City metro area. Altice Europe spun off Altice USA, which includes both the Suddenlink and Cablevision operations, to shareholders in 2018.
  • Altice USA continued to struggle during the third quarter, reporting poor customer losses, weak revenue per customer and soft margins. On the brighter side, the firm’s network upgrade effort has accelerated nicely, and management indicated that it has seen signs of a turnaround thus far during the fourth quarter. New CEO Dennis Mathew stated he’s taking a hard look at marketing, pricing and customer service. Continued poor execution, especially if Altice fails to complete some sort of M&A restructuring in the near term, could leave the firm in a precarious position as it seeks to refinance debt down the road. Total revenue declined 4.3 percent, excluding the nonrecurring revenue recorded a year ago, as Altice lost another 50,000 net customer relationships during the quarter. The firm had offered hope last quarter that its efforts to deploy fibre, expand into new areas and improve marketing would drive a return to customer growth during the second half of the year.

Credit Suisse Group AG ADR 

  • Established in 1856, Credit Suisse Group is a global financial services firm based in Zurich, Switzerland. The firm operates as an integrated bank through two global divisions: private banking and wealth management, and investment banking. Credit Suisse's client base includes ultra-high-net-worth individuals, large and mid-sized companies, entrepreneurs, institutions, hedge funds, and affluent clients in Switzerland and around the world. 

Outlook

It is hard to imagine a more brutal year than 2022, which saw global stocks down by double digits, although the longer-term picture is much more balanced. A key variable that many investors are watching in 2023 is the degree to which corporate earnings are able to remain resilient, or if expectations are too high, which could spell more trouble for the market. That said, a potential burst of optimism is that central banks might be able to pause rate hikes and ‘pivot’ to lowering rates. 

Much of these macro issues are unknowable and it is therefore dangerous to presume a certain pathway. To overcome these temptations, an investor must think probabilistically. The correct question is not ‘what is the market going to do next?’ but rather ‘are assets priced reasonably for the current environment?’

Heading into 2023, bearish sentiment among investors is at the highest it’s been since tracking such data started 35 years ago. With a contrarian lens, this could be a positive. However, while the overall valuation landscape has undoubtedly improved, there are many assets which remain around fair value.

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