Light at the end of the tunnel

Our speakers struck an optimistic note this week as we considered the prospects for investors at the end of a difficult year…by Pascal Dowling

 
Sentiment could be approaching an inflection point according to Simon Gergel, co-manager of the Brunner Investment Trust (BUT), as we approach the end of a weary year which began with a COVID hangover and has since seen the outbreak of a vicious war in Europe, soaring inflation and increasingly sour relations between the West and China.

Speaking as part of a series of webinars on Kepler Trust Intelligence last week, Simon said rapidly increasing interest rates – the latest in a succession of blows to the outlook for equities – might prove to be a short-lived phenomenon as inflationary pressures begin to recede.

“If you look at what’s been driving concern in the market it’s been the massive spike in inflation and the response of central banks to interest rates. If you look forward six months you are already seeing some of those inflationary pressures easing. The oil price has fallen, the freight rate which was a big cost for many businesses is almost back to where we were before the pandemic, and gas prices are easing off – although granted we are only at the start of winter.

“Many other commodities, though, are also cheaper. I saw a company last week who said apart from lithium most of the costs they’ve got have come back a long way. A lot of those inflationary pressures are starting to annualise out so, looking forward, while wages are going up the inflation rate should start to peak and then come down.

“If the economy does slow, then the question for central banks will change from ‘how quickly can you raise interest rates’ to ‘at what point do you stabilise or perhaps even bring rates down’.

“On a three to six month view we will be talking about when interest rates are coming down. That environment would normally be a positive one for investors, but at the moment I think we are at – or certainly approaching – peak fear and peak pessimism when it comes to the macro.

“If you’ve sensibly priced markets, and the potential that we are near the worst point in terms of fear, that’s a good combination on a long-term basis to be investing.”

Simon said the best approach – even with that optimism in mind – for investors was to avoid binary bets on macro outcomes, and instead focus on creating a diversified portfolio within which individual holdings could perform well regardless of the macro weather.

This balanced approach to investing has served Brunner well over the long term, and has helped it perform well in recent difficult markets.

It is among the top performers in the AIC Global sector over three years to 07/11/2022, delivering NAV returns of just under 30%, and defending that performance well over the last year during which the average trust in the sector is down 22%. Brunner is down just 5%.

Despite this strong performance, the trust remains on a discount of 12% – wider than the peer group average of 8%.
 

View slides and audio for BUT >

 
Dean Orrico, president and CEO at Canadian asset management business Middlefield International – and portfolio manager of Middlefield Canadian Income (MCT) – struck a similarly positive note as he joined us to discuss the prospects for the strategy, highlighting the significantly lower inflationary pressures facing equities north of the 49th parallel.

“In Canada there are signs that inflation has already rolled over. We heard the governor of the Bank of Canada saying that he thinks we are starting to get things under control and that looking forward interest rates may not need to climb so steeply. With that in mind we may well see the next rate rise at the next BofC meeting at only 25 basis points, which bodes well for equities in this market.”

That said, Dean thinks inflation will continue to run hotter than it has in recent decades, as globalisation continues to retreat.

“We are now in an era which marks the early stages of deglobalisation and this is inherently inflationary, so inflation is not going to go away.

“That period in which we saw high duration equities which benefit from low interest rates is now firmly in the rear view mirror. This means people should be looking for investments that are a hedge against inflation and cyclical, value oriented equites are the best way to do that.”

Middlefield Canadian Income offers exposure to the high dividend and growth potential in Canadian equities. Canada is a net energy exporter and its market has a high weighting to energy stocks, as well as to companies producing some key hard and soft commodities that are currently in high demand. The market is heavily weighted to financials, which benefit from a rising interest rate environment, and MCT has a structural overweight to REITs, which offer decent inflation protection.

Despite this appealing position, and a yield of 4.3% which beats that of any of its peers in the AIC North America sector, the trust continues to trade on a discount of almost 15%, wider than any of its comparable peers in the AIC North America sector.
 

View slides and audio for MCT >

 
Meanwhile Chethan Seghal, co-manager of Templeton Emerging Markets (TEM), highlighted the attractive valuations which can now be found across the developing world.

“Emerging markets equities are discounted much more heavily than their developed counterparts, and emerging markets currencies are discounted as well. At the same time debt ratios among emerging markets countries tend to be lower than they are in developed markets,” he said, “So they still have the potential to access credit more easily.

He continued to point out that the traditional appeals of emerging markets – cheap labour and ample commodities – still support the case for investors in the developing world, but demographics and the growing wealth of consumers is also a significant factor.

“86% of the next billion middle class consumers are going to come from Asia.”

TEM is one of the EM sector’s oldest investment trusts with a track record stretching back more than thirty years. The trust is managed with a bottom-up stock selection approach and the team seek companies that offer quality growth over a five-year horizon that are trading at a discount to their intrinsic value.

Trading on a discount of 13.2% itself – wider than the peer group average for the AIC Emerging Markets sector – the trust offers an interesting option for those considering exposure to the region.
 

View slides and audio for TEM >

Disclaimer

This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.