High inflation, rising interest rates, and pandemic disruption to global supply chains are issues that we are all facing, investors and consumers alike. Investment markets have been grappling with their effects for months now, and together with war in Ukraine, the result is that both bonds and stocks have fallen year to date.
The last calendar year that both bonds and equities fell was 2018, when the market grew concerned that the Federal Reserve was raising interest rates into a slowing economy. Sound familiar? The only other time in the last 30 years was 2008 and the onset of the Global Financial Crisis.
Of course, some segments of the market have fared better than others, which is why the Endeavour Fund invests across the breadth of the economy. The current earnings season is timely in giving us evidence on how individual companies and their customers are coping in the current environment, and what they are expecting to come.
Inflation is an acute problem for consumer-facing companies. Higher prices are one way to protect profit margins from higher costs and this quarter PepsiCo reported a rise in prices of 10%. But as well as the strong brands needed to successfully implement higher pricing, the likes of PepsiCo have a wealth of experience in dealing with inflation through operational cost management. PepsiCo said that they do not expect profit margins to fall this year despite cost inflation, while raising their revenue growth outlook too. This illustrates the company’s defensive strength and why PepsiCo is a significant and long-standing holding in the Endeavour Fund.
To combat inflation central banks are starting to raise interest rates. In theory, this should be beneficial for banks as they earn more interest on loans; but not if loan demand drops due to recession fears, reflected in, and precipitated by, the inversion of the US Treasury yield curve. Bank of America, a top ten holding in the fund, was the first major US bank to see loan growth last year, and it has continued to accelerate this year. They also highlighted the resilience of the consumer with household savings in the US at $2.9 trillion above pre-pandemic levels. While this must be viewed against US GDP figures showing a contraction in the first quarter (distorted by some clear anomalies), it demonstrates why we are more confident about the continued expansion in the US than other developed markets this year.
One hurdle to economic recovery has been supply chain issues caused by lockdowns and Covid absences. In countries where restrictions have been lifted, these supply constraints are easing. Union Pacific, the US railroad operator, and another top ten holding in the fund, reported significant growth across all freight types in both volumes and pricing. This is further evidence the US economy is recovering well. Whether it continues to do so depends, to some extent, on China. For unless China changes its zero Covid policy, further lockdowns, and disruption to global trade seem inevitable.
Covid is, for now, in the past for the world’s other major economies. Roche and Abbott both benefitted from increased Covid testing in the quarter, yet other treatment areas were impacted. Encouragingly, Roche has not factored in any further waves of the pandemic in their guidance for the year, and as Covid recedes, so too will disruption to treatment for other diseases. Roche, Abbot, and the Endeavour Fund’s largest holding – AstraZeneca – should all benefit from this. Due to the nature of their business, these companies are less affected by inflation, higher interest rates and supply chain issues, and healthcare is now the largest sector weight in the Endeavour Fund.
Despite the many issues concerning investors, this earnings season has generally painted a positive picture so far. Will that last in the face of higher inflation, higher interest rates, and higher tensions over Ukraine? We cannot answer that, but we find the resilience demonstrated so far by many of the companies we are invested in reassuring for what may come in the months ahead.
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