Commentary for the quarter ended 30 September 2024
There really is only one way to describe what has unfolded in 2024 – Pure Risk On!
The Economic Backdrop
It is well documented that the US yield curve started inverting in July 2022 – this occurs when short-term interest rates exceed long-term rates.
Past yield curve inversions have been great predictors of recessions as high interest rates starve the economy of liquidity, raise the cost of borrowing, suppress corporate earnings and compress P/E multiples. Under these conditions, the market usually cavitates.
Whilst we have seen a classic yield curve inversion this year, its real effects have been limited in terms of economic consequences. In fact, the market is expecting 2024 S&P 500 year-over-year earnings growth of 9.7% with much of that back-end loaded in Q4, EPS growth of almost 15% is predicted.
A lot of good data is driving the market. Despite all the noise, inflation is dropping – in September, the US’s inflation print (headline) was an incredibly benign 2.4% (9.1% in June 2022), the lowest level since February 2021. US core inflation, which is at 3.3% and regarded as sticky, should be compared to September 2022 levels, which reached 6.6%. Massive progress has been made on the inflation front.
Growth has also been resilient. The IMF believes that the world will enjoy GDP growth of 3.1% in 2024, like 2023 but have a slight lift in growth next year, to 3.2%. The USA grew by 2.9% in 2023 and is expected to grow by 2.7% in 2024. Certainly, no obvious signs of a deep malaise or recession.
In theory, this is goldilocks kind of stuff – falling inflation, steady, but not run-away growth and the onset of easing interest rates. But it is also precipice walking, the market understands a lag of about 18 months exists between higher interest rates (the Fed started increasing rates in March 2022, with the Fed funds rate at effectively 0%, finally topping out at 5.50% in July 2023) and a recession.
What has unfolded is a deeply divided market – one camp believing that higher rates would play-out conventionally and hurt stocks, against the other camp, who believe that the fiscal injections made during Covid would continue to dampen tighter monetary policy and cause an immaculate economic cycle.
The only way to ascertain whether either one of these views is right, is time and it will happen through the release of inflation and growth data. As these data points arise, the market has actively swung between sectors and styles that best represent that data point – effectively betting on either a slowing or growing economy.
Quarter Three – Market Dynamics
In Quarter 3, particularly the first two months of it, market participants were firmly of the view that growth was slowing, but not collapsing, inflation was under control and interest rates would be cut.
This scenario catalyzed rotation out of large cap stocks (MSCI Large Caps +5.8%) and into the un-loved mid and smaller caps (MSCI Small Caps +9.4% and MSCI Mid-Caps +10%), out of high growth sectors such as Information Technology (+1.5%) and into defensive plays such as Consumer Staples +9.2% and interest rate sensitive spaces – the likes of Utilities (+17.6%) and Real Estate (+16.6%).
Style rotation also took place with Value gaining 9.6% against Growth at 3.5%, Quality 3.8% and Momentum 3%. This being a complete about turn, against the moves seen over 12 months, Value had gained a respectable 27.2% but been completely muscles out by Growth +37.5%, Quality +37.6% and Momentum +45.6%.
This benign world viewed as low risk and investor friendly, also led to significant rallies in other risk assets. US treasuries with a 20 year plus duration gained 13.4% in the quarter, gold climbed 13.7%, the MSCI Emerging market index rose 8.7% and laggard currencies such as the South African Rand and Japanese Yen rallied +5.5% and +10.9% respectively, against the US$.
Fund Performance
The Northstar Global Flexible Fund produced a strong quarter, gaining 7.82% in dollars versus the EAA Fund USD Flexible Allocation Sector, its peer group, which returned 3.98% in dollars. The Northstar BCI Global Flexible Fund (the SA based version of the fund above) returned 1.98% in Q3 (in ZAR) against the ASISA Global Flexible Sector which did -0.57% (in ZAR).
Continuing with the long-track record of this strategy inside Northstar Asset Management, its success is attributable to stock selection but for the quarter, the rotation out of momentum and growth styles and into defensive value, played squarely into the sweet spot for the fund.
The fund’s largest sector underweight bets included Information technology, energy, materials, and utilities. Not owning utilities and materials detracted from performance, but being underweight Information Technology, which is expensive and highly reliant on continuing high earnings growth, added significantly to performance, with tech returning a mere 1.5% over the three months. The underweight in energy was also a positive contributor to performance.
All sector over weights, which include financials, industrials, consumer staples and healthcare, added favourably to performance. The largest sector attributors were consumer staples, industrials, and healthcare.
Very pleasing was the fund’s hit rate for the quarter at 70% (this is the number of stocks in the fund that outperformed the benchmark, being the MSCI World Index). A characteristic of the 13 years of managing global portfolios at Northstar, has been the annual hit rates, these have always been higher than the benchmark hit rates, and we view this as a critical indicator of stock picking success. The Benchmark hit rate was 63.9% in Q3, in other words about 64% of the stocks in the index, beat the index, this is a good sign of a broadening market rally.
Another pleasing statistic was the win-loss ratio, in the fund, this is the extent to which the alpha that winners generated, exceeded the negative alpha created by stocks that underperformed the index. This quarter, our win-loss ratio was 227%, a number above 100% indicates that the manager is weighting the portfolio well. 227% rates as one of our highest levels since managing these mandates in late 2012.
The largest stock attributors for the quarter were DSV, Alibaba, Philip Morris, Jones Lang and not owning Nvidia. We are pleased with the Alibaba outcome, having added to Chinese exposure against a backdrop of doubters that called China uninvestable. The fund also owned Tencent. The significant rally seen in China has led us to cut some of our outperforming positions as they have reached intrinsic value.
Prospects
Despite a particularly good Q3, we are clear that a performance history is not made over one quarter. Instead, it arises through persistent application of an investment process that generates reliable outcomes that compound over the course of time. Since 2013, the Northstar Global Equity portfolio has generated 2.4% of annualized alpha above the MSCI World Index and since 2017, this has been 3.5%. (these are gross of fees).
What encourages us is that our strategy has outperformed in various market dynamics – sideways, falling, and rebounding markets and as well holding its own in differing market cycles – growth, value, and momentum.
The strategy is well tested and the litmus test is performance, since launching the Northstar Global Flexible dollar fund over seven years ago, it is ranked 6th out of 112 global peers from inception and its consistent performance is illustrated in rankings – 19th percentile over 1 year, 24th percentile over 3 years, 14th percentile over 5 years and 6th percentile over 7 years. This in a sector that has swelled to 264 funds.
We believe that our structured approach should sustain peer beating returns and given extended global equity valuations, our quality at a reasonable price style should do well.