Vermeer Monthly – January 2024

December was another strong month for global equity markets in what proved to be a great year for stock markets around the world. Once again, the US market was the main driver of performance with the S&P 500 rising by over 26%. Japanese equities did even better in local currency terms, with the Nikkei rising by over 30%, but once again the weak performance of the Yen negatively impacted overall returns and fund performance. Sterling had a slightly better year in 2023, strengthening over 5% against the Dollar. The Vermeer Global Fund returned 16.3% in 2023, 3.6% better than the global peer group.

For much of the year it was the so called “magnificent seven” that drove nearly all of the performance of the market but in the latter stages of the year the rally broadened out to many sectors. In fact, although most of the magnificent seven finished the year close to their respective all-time highs, they mostly saw their peak levels earlier in 2023. Indeed Apple, which we substantially reduced over the second half of the year, actually saw its peak at the end of July but was still up just under 50% for the year as a whole.

December’s strong performance can be attributed to the long-awaited Federal Reserve pivot on interest rates. The final FOMC meeting of the year was highlighted by the unexpectedly dovish commentary of Chairman Jerome Powell. Although investors had already moved to anticipate lower interest rates in 2024, with a material shift lower in both bond yields and interest rate futures, it was widely expected that Mr Powell would maintain a more hawkish stance. However, the Fed shifted to a much more dovish position signalling the potential for three rate cuts in 2024 and four more cuts in 2025. Investors immediately viewed these projections as too conservative and have pencilled in as many as six 25 basis point cuts in 2024 alone.

Inevitably stocks reacted positively to the commentary and the expectation of further positive inflation data as we move through 2024. While we have run with a fully invested portfolio in the latter part of 2023, we are somewhat concerned that equities are simultaneously anticipating that rates will be cut aggressively at the same time as the economy continues to hold up well, which it clearly did in 2023 despite the significant rise in interest rates that put pressure on some areas of consume spending. This seems to us somewhat unlikely, as if the economy continues to perform well, the scope for rate reductions will likely be considerably less than currently forecast. If, on the other hand, the economy does weaken more substantially, then greater cuts could be necessary, but this would also be accompanied by a weaker earnings performance for the market, which would likely hamper the performance of equities after such a strong run in 2023.

Nike was virtually the last company to report results in 2023 and its disappointing outlook statement created a note of caution for consumer spending, but we feel also highlights a considerably more competitive environment for the strongly growing athletic wear industry. Nike shares had a disappointing year and although it remains a very powerful franchise, we do have some concerns that both new industry participants and more established competitors such as Adidas and Under Armour have materially improved their offerings recently following a number of years of weakness. We are currently reviewing this position in the portfolio.

Accenture produced another set of solid quarterly results in December and has continued to perform well as investors anticipate the company continuing to be a winner from the emergence of greater investment in artificial intelligence. Accenture is well placed to benefit from this spending as a global leader in the digital transformation and cloud transition and utilisation. Corporate spending on AI with Accenture is already picking up at great speed and although it is currently a small part of overall revenues, we anticipate that its growth trajectory will only accelerate further. Accenture shares had a strong year, rising over 33% and finishing close to an all time high above $350.

Nuclear power industry leader Cameco had a very strong year in 2023 rising by 90%. In December the company held an investor day, which followed hard on the heels of the United Nations Climate COP 28 meeting, which took place in Qatar. COP 28 clearly demonstrated the increasing role that nuclear power has to play in any successful energy transition that enables the world to achieve its climate and emission reduction goals. More than 20 nations signed a declaration that aims to triple nuclear capacity by 2050 and US climate envoy John Kerry noted that the world cannot achieve its net zero ambitions without building more nuclear reactors. Cameco’s investor meeting demonstrated that the company is well placed to remain a leader in nuclear power’s role in the energy transition, both through the production of uranium, which it is in the process of ramping up, the possibility of being able to bring on new capacity from assets that previously had not been mineable and also the provision of services throughout the supply chain which is has been substantially augmented by the recently completed acquisition of 50% of Westinghouse. Cameco has an excellent management team that we have met with regularly over the last two years and we remain confident that although the stock has moved up substantially in the last few years, the investment case for the company remains firmly intact. Part of the reason we added a new position in Rolls Royce to our portfolio in November was its potential in small modular nuclear reactors, which we also believe will have a significant role to play in the development of the industry.

As noted earlier, Japanese equities had a strong year, although the weakness of the Yen once again detracted from overall performance. Despite persistent rumours that the Bank of Japan would row back from its yield curve management strategy, the final BoJ meeting of 2023 showed no such intention and policy was left unchanged. A shift in US interest rate policy has been helpful to Japanese policy makers and the Yen has strengthened from its mid-year lows, but in our view, this has been a function of Dollar weakness.

Toyota Motor had a mixed month of news, with a very positive November sales and production update offset by a disappointing announcement from its Daihatsu brand that it was halting shipments of all cars following safety irregularities. Although this represents a small percentage of Toyota’s overall profitability it is a significant blow in sentiment towards management that had improved notably in 2023 after the company began the process of reducing a vast array of unnecessary stakes in other companies. Toyota was targeted by the Tokyo Stock Exchange as a company that was doing an inadequate job in managing shareholder interests and allowing its stock to sell below book value. Toyota shares fell by 7% in December but were up over 47% for the year as a whole.

We believe that Japan remains an attractive opportunity and that improved corporate governance remains central to the investment case. We believe that further improvement in corporate behaviour towards investors will continue to unlock considerable value in companies with excessively strong balance sheets. It remains to be seen whether the worst of the persistent currency weakness is now over but a combination of looser monetary policy in the US and Europe and some further allowance of yields to drift modestly higher than the indicated current 1% ceiling may at the very least create more stable performance and help sentiment towards the Japanese market improve further.

The Chinese economy and stock market had a difficult year in 2023. A poor recovery from COVID restrictions that were lifted in late 2022 and substantial problems in the real estate sector weighed heavily on performance throughout the year. Our decision to buy back our investment in Carl Zeiss Meditec early in 2023 proved premature, but the stock did rally meaningfully towards the end of the year following quarterly results and a tuck in acquisition announced at the end of 2023 helping the shares rise from a late October low of €74 to finish the year at €99. Carl Zeiss has great technology and a phenomenally strong balance sheet and will benefit from the recovery in Chinese healthcare spending when it eventuates. This will also benefit other stocks in our portfolio including Danaher and Zimmer Biomet, although we did make the decision to exit our position in Olympus after a disappointing meeting with management.

The European economy continues to underperform, not helped by the weakness of the Chinese economy, which it relies on heavily for exports. As with the US, investors anticipate a substantial fall in European interest rates in 2024 but at this stage the ECB is refusing to acknowledge that it will be forced to radically change course on rate policy. Despite economic weakness, a number of stocks in our European portfolio had good years. The economic tailwinds from investment in electrification proved a very powerful driver for Schneider Electric, whose shares rose over 40% in 2023, and although the initial timing of our investment in Siemens in early August was not opportune, the stock enjoyed a very substantial recovery after its excellent results and bounced from a low of €121 in late October to close the year at nearly €170.

One of the key themes of 2023 was the performance of the two pharmaceutical companies involved in the development of GLP-1 weight loss drugs. We have positions in both Novo Nordisk and Eli Lilly, although we reduced Novo through the year on the back of its exceptional performance. The future for these products is potentially enormous and demand is clearly outstripping supply on a global basis, and this is likely to continue for the foreseeable future. However, like the magnificent seven these
stocks slightly ran out of steam into the year end, and we are keeping a very careful eye on industry developments as we move into 2024.

2023 demonstrated just how hard it is to predict the year ahead in global stock markets. Very few would have anticipated such a strong performance given high interest rates, the failure of a number of banks, the continued war in Ukraine and the outbreak of hostilities in the Middle East. However, the US economy has proved very resilient, inflation is coming down at a healthy rate and the market moved strongly to anticipate lower rates in 2024 and is hoping for a soft landing. It is too early to determine just how fast the Federal Reserve will cut rates and this may hold the key to the market’s performance alongside the uncertainty of timing of any improved economic performance in China.

We noted the end of the so-called TINA trade (there is no alternative to equities) a number of times in 2023 but the strength of the recovery in bond markets ultimately only helped equities. This would only be likely to continue in 2024 if strength in bond markets is not driven by fears of a global recession. There is also the considerable uncertainty caused by US presidential elections later this year, but we view positioning ahead of this as currently premature.

We will be maintaining our current positive stance to markets in the early part of the year but will be very vigilant to any changes we need to make to move to a more defensive stance as the year progresses.

 

Tim Gregory
Senior Fund Manager
Vermeer Investment Management