The summer solstice has been celebrated at Stonehenge for millennia. It is a significant time of the year for us at Tellsons too; not because of the position of the sun in the sky, but because first half earnings season is upon us. And this year it is even more important than usual.
Recent macroeconomic data releases would be better compared to midwinter than midsummer. Inflation remains persistent, sentiment remains weak, and central banks remain seemingly behind the curve. As expectations for further interest rate rises have increased, economists and strategists have downgraded economic projections and increased the likelihood of recession.
But a recession is not inevitable in the near-term. The balance sheets of consumers and corporates are much healthier than would be typical when on the brink of a recession. And it is this that the earnings season will give us critical insight into. How healthy is the consumer, and in turn corporates, and what are their chances for the coming winter?
These concerns are already reflected in equity markets that have accordingly become less expensive. For example, the forward price/earnings multiple of the S&P has fallen in the past year from 24x to 16x. So far, this de-rating is primarily due to the significant drop in price of equity markets since the start of the year.
But a multiple of 16x is at best only back to around the S&P’s pre-pandemic 20-year average. The multiple should fall further if a recession becomes reality. And if earnings are downgraded after companies report their first half results, then it follows that share prices will need to fall further too.
So, the outlook for stocks is a precarious one. On one hand, if inflation falls quickly and the consumer is resilient, stocks could rally; but if we do head into a recession later this year, then they should fall further. In the Endeavour Fund, we have therefore been seeking out those companies, whether defensive, cyclical or growth in nature, that we believe offer resilience for the uncertain times ahead.
We are overweight healthcare companies, which are generally less exposed to the impacts of inflation and recession due to the nature of and demand for their products. Amongst them, AstraZeneca has had a good first half of the year with the share price up 18% on the back of a run of successful trial results and the fading of negative news around its non-profit Covid vaccine. While AstraZeneca still faces headwinds in China, where Covid is still a factor, its compounded annual growth rate of 20% over the next few years when the world is facing a recession is why it is the Endeavour Fund’s largest equity position.
One of the causes of the high levels of inflation is the increase in energy prices. Our investment in Shell is a long-standing one, as we see the company as critical to the structural theme of the energy transition. But this year it, and our other energy investments, has acted as a hedge to the rising oil and gas prices that have impacted profit margins for many of the companies that we invest in. As risks of recession build however, we are aware that demand for oil will fall. Whether that is enough to cause the oil price to fall significantly remains to be seen, but we retain our exposure in case it does not.
The post-pandemic shift in working practices has made cloud-computing a vital requirement for companies, which a recession will not change. We own shares of the three largest cloud-providers: Amazon, Microsoft and Alphabet. Of these, Microsoft is the second largest, while its software products dominate the corporate world. These software solutions have also become more affordable for companies if delivered via the cloud. IT companies are among the hardest hit this year and while the pain is not necessarily over for the sector, we believe necessity and affordability make Microsoft’s a resilient business model in the face of a recession.
At Tellsons, we are not going to predict if, or when, or what type of recession there will be; but the upcoming earnings season will help us in our positioning of the Endeavour Fund. Currently the fund is skewed towards defensive equities and corporate bonds for income and downside protection. But we believe that by investing in defensive, growth and cyclical stocks of the types highlighted above, the Endeavour Fund should be resilient across the range of economic outcomes that we face in the second half of the year and beyond.
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