The Brunner Investment Trust: A new phase – how will markets react?

 

 

 

In their first catch up of 2022, Joe and Matthew look at the issues that markets have faced in the early part of 2022 and how some of those factors may play out over the coming months[Text Box] 

 

Joe Lynam: Hello and welcome to the ninth and latest instalment of Connected Investor, the podcast from the Brunner Investment Trust.  

I am Joe Lynam, the BBC presenter and Newstalk business editor, and in this podcast we’re going to talk about some of the geopolitical and economic factors that investors have been digesting so far this year and how it may affect you, the markets and, of course, the Brunner fund.  

As ever I’m joined by Matthew Tillett, the Lead Portfolio Manager of the Brunner Investment Trust. Matthew, it’s been an extremely volatile start to the year – what have the markets had to digest since we last spoke?  

 Matthew Tillett: So the big change that’s happened is regarding interest rate expectations. The markets are now expecting a number of interest rate hikes this year, and that’s really changed actually in the last month or two. The reason for that is the realisation that the inflation that we’re seeing in the economy is not really going to be transitory, at least not in the way that the central bankers in Europe, in the U.S, had been saying and hoping it would be last year.  

 

‘We find opportunities across the whole spectrum of growth and value stocks’

 

What we’re seeing is a combination of supply side issues restricting the supply of certain goods, but actually the demand side is also really quite strong and has come back quite powerfully, as a result of all the stimulus that was put in place during Covid. And now we’re seeing economies reopen as well as the Covid restrictions coming off, which is likely to put more pressure on the demand side.

Market participants are now expecting interest rates to rise quite a bit this year, and the impact that’s had has caused a really quite savage rotation within the stock market. What we’ve seen is the so-called growth stocks – which are basically companies that are growing rapidly, they have most, or a lot of their value quite far into the future, typically because they’re on high valuations, near term earnings – those stocks have come down quite heavily, I mean really significantly in some cases. Because interest rates are moving up, investors are using a higher discount rate to discount those cash flows.  

And the flip side is also true in that the so-called value stocks – the companies that trade on low evaluations of current earnings or cash flows – have generally done better, because again, the mathematic works in their favour.  

I should say that we in the Trust largely rather reject that whole dichotomy and we find opportunities across the whole spectrum of growth and value stocks, but the market does tend to be very, very sensitive to these things, and so you get these really big rotations. And we’ve had quite a few actually over the last few years, but particularly since Covid, and this one has been particularly severe in terms of the intra moves within the market. I think January was the second-best month on record for value versus growth, just to give you an idea of how extreme it’s been. So that was what was going on really in the first few weeks of the year, and then obviously now more recently we’ve had the terrible conflict started up in Ukraine to deal with, which has thrown up a whole load more issues. 

  

JL: Will the huge sanctions against Russia by the EU, US and UK on Russia, which is such a huge gas exporter, delay or reduce the interest rate hikes that we’re all expecting, especially in the States? 

  

MT: On balance it probably does, Joe, but we have to remember that there are factors working both ways here, and I think the reason why central banks are looking to raise interest rates is really because of inflationary pressures that we’re seeing across the economies in the US and Europe in particular, but also elsewhere. Unfortunately, the situation in Ukraine, the conflict, is actually going to accentuate those problems. If you think about what’s happening: disruptions to oil markets and gas markets – Russia is a big supplier of oil, biggest supplier of oil, and it supplies over 40% of gas to Europe and we’re seeing some quite sharp price increases, as the sanctions come in and I think also market participants kind of anticipating what may happen in the future. 

 

‘Unfortunately war tends to be inflationary, because it disrupts production and it stops the flow of goods’

 

 Also Ukraine is quite important for food markets – big producer, exporter of wheat – so that’s going to obviously be disrupted, will put up the pressure on food prices. Unfortunately war tends to be inflationary, because it disrupts production and it stops the flow of goods. But having said all of that, monetary policy, which is what central banks have control over, you can’t really do that much about that sort of disruption. It really works through the demand side. So I’m not sure they would really respond to that sort of inflation by becoming more hawkish than they already are. 

 Would they become less hawkish? Well, possibly. I think here it would probably depend a bit on what the economic impact is, and there clearly is going to be an economic impact from what we’re seeing. We just look at the extent at which prices have been going up and will continue to go up. It’s going to have an impact on consumers. It’s going to affect real incomes. Real disposable income is probably going to go down in many countries this year, and that will have a negative impact on economic growth, which other things being equal, would suggest that the central banks probably would be less inclined to raise interest rates.  

It’s also, as we’re seeing on a daily basis, having a negative impact on financial markets. Central banks increasingly are very focused on financial markets, really ever since quantitative easing, it has become so embedded in the system; the financial markets themselves have become an important mechanism through which their policies can impact the economy. And so if financial markets are very weak, then that could also cause them to take their foot off the accelerator. I don’t think we’re quite there yet, but we could get there. So on balance I think I’m with you, I think yes it probably does make it a bit less likely, but we have to keep in mind that there are factors working both ways here. 

  

JL: A few moments ago I mentioned a notable market rotation. Can you tell us a little bit more about that and how it’s reflected in the performance of the markets?  

  

MT: Yeah, it’s been a real savage rotation that we’ve seen in the first weeks of 2022, and by rotation what we mean when we say that is really actual rotation within the stock market, and in this case it’s been away from growth stocks and into value stocks. Growth stocks being those companies that are experiencing rapid growth in revenue and earnings, and typically trade on high evaluations where much of the value is earnings and cash flows that are expected to be delivered a long way in the future. Whereas value stocks are those where the valuations are lower and there are more cash flows and earnings in the here and now.  

And we’ve had a few of these rotations over the last two or three years and especially since Covid, but this one has been particularly severe and the catalyst for it has actually been what you referenced in your previous question: the rate hikes that are happening in the US and the realisation from the market that this is actually going to happen, or at least people are now expecting it to happen.  

And that’s caused the evaluations of particularly the growth stocks and in particular I’d highlight the very top end of that, what we call spec-tech, or speculative technology. These are some of the real highflyers of 2020 and 2021; in many cases, companies that have very little earnings or no earnings, in some cases don’t even have any revenues, that have gone to very high valuations, and they’ve just really fallen hard as there’s been a reappraisal of what the right valuation is for that profile a company.  

It has also impacted the more established high-growth companies – the Microsofts, the Amazons, the Apples – the big companies that led the market, they’ve come off as well. Again, it’s the same factor driving it, really just a de-rating rather than anything fundamental that’s changed. At the same time, you’ve got some sectors that historically have very much been in the value camp. I can think of banks, banks clearly big beneficiaries of rising interest rates and evaluations still are quite low, so they’ve done quite well. 

And, of course, the energy sector, which is again also a pretty lowly valued sector, but it’s also benefiting at the moment from higher oil and gas prices and the general inflationary environment. So that’s the backdrop really; that’s what’s been going on so far this year. 

 

‘we like volatile markets; we like it when there are big moves, because it creates opportunities for us’

 

  

JL: And how has the Brunner Investment Fund behaved since we last spoke? 

  

MT: I’d say actually it’s throwing up opportunities. It’s a good environment for us. We’re stock pickers, we like volatile markets; we like it when there are big moves, because it creates opportunities for us. And we’re already finding opportunities, particularly amongst some of those high-quality, high-growth companies to look at new ideas for the portfolio.  

  

JL: So Matthew, the Brunner annual report was published very recently. What stood out for you in that report?  

  

MT: Well, I think one of the challenging things was obviously writing this over Christmas period. Clearly 2021 was a very good year for the markets, good year for the Trust, good year for the portfolio, but clearly thinking about the outlook and some of the risks that are on the horizon, and we did talk quite candidly to shareholders about the risks that we foresaw, and one of those risks was actually kind of what we’ve just been talking about, which was highlighting some of the quite speculative behaviour that had been occurring, particularly in the US market and the way in which that was affecting valuations in certain parts of the market. Not really so much in the companies that we’re investing in, but that was definitely a major risk factor for investors to consider for the market as a whole. 

But then of course we found ourselves having to amend some of what we’d written, because within the first two or three weeks of the year we’d already largely seen a significant chunk of that risk actually play out, in the sense that many of those real speculative technology companies have really fallen a very, very long way now. So it shows how quickly the market can move in and things can change. 

JL: Thank you very much, Matthew. Matthew Tillett, of course, our Lead Portfolio Manager with the Brunner Investment Trust. That’s all the time we have for this episode of Connected Investor. Thank you for joining me. Make sure you’re subscribed to Connected Investor wherever you get your podcasts so you don’t have to go hunting for it next time. And thank you all for listening. We value your views and we’d be keen to know what you think, so get in touch: contact us via the website, which is www.brunner.co.uk. From me and from Matthew, ta-ta for now. 

 

 

Find out more about The Brunner Investment Trust PLC here > 

 

Brunner 2022 AGM – Investment Manager’s Update 

 

Ahead of the physical AGM in 2022, Portfolio Manager Matthew Tillett recorded an investment update for shareholders from the London office.

 

 

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