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Written by the Mackenzie Global Equity & Income Team
Market Outlook
Over the past year the US has hiked rates to 5%, more than any other developed country. Given the influence the Federal Reserve has on almost every other central bank’s monetary policy the rest of the world has followed suit to a large extent. Notable exceptions include Japan, which has maintained its zero-interest rate policy amidst moderate but still higher than usual inflation. China has had to cut interest rates over the past year in the face of low inflation and, thus far, a lackluster economic rebound. The rate hikes have effectively had their desired impact in the form of slowing growth. As a result, inflation has begun to moderate in the US and the Eurozone but is still hovering above levels that most central banks would target before declaring victory.
With yield curves inverted around the world, investors are currently facing a bit of a conundrum. Inverted yield curves typically indicate we are in a recession, but this is somewhat of a contradiction versus the solid if not unremarkable economic signals and relatively bullish earnings expectations. For example, we have yet to see a notable slowdown in the results of our industrial companies, and our consumer franchises’ ability to pass along higher prices without a significant hit to volumes has been impressive. Economic forecasting is unreliable at the best of times as monetary policy acts with long and variable lags. Still, over the past 50 years every persistent and significant US yield curve inversion has been followed by a recession within 18-24 months. As of June, we were 15 months in. Note that the recession didn’t usually start while the yield curve was inverted, but rather after the US Fed had started cutting rates to fight the perceptions of an economic slowdown. Based on that long history, it would not be unreasonable to expect a recession not this year, but perhaps in 2024.
Of course, over the years we’ve come to believe that neither economists, nor management teams, nor sell side analysts or (especially!) buyside portfolio managers are great predictors of recessions. It is why we insist on owning companies whose business models, balance sheets and dividend and free cash flow streams are capable of withstanding downturns – expected or unexpected.
What contributed positively to performance?
Broadcom was one of the biggest contributors to performance. Broadcom consists of two segments: one quarter of their profits come from infrastructure management software and three-quarters come from semiconductors, where their products (merchant silicon chipsets, customer ASICs, ethernet switches) play a foundational role in the enablement of AI and data center efficiency and are essential to the continuing growth of the cloud titans. We continue to own Broadcom, which at 20x current earnings is reasonable given their prospects and the fact that it is run by a CEO (Hock Tan) who has compounded shareholder returns at over 35% per annum going on 15 years.
McKesson was a top performer for the quarter after it raised its long-term operating income growth target for its key operating segments. This is being driven by strength in the generic drug pipeline, headlined by the genericization of Humira, and the continued development of a high margin community oncology franchise. McKesson has a leading presence in oncology with over 2000 oncologists on their platform which provides high margin value added services to oncologists and drug manufacturers. This is significant since oncology dominates pharmaceutical R&D, accounting for roughly 40% of 2022 R&D, and is expected to be the fastest growing therapy area over the next five years with an estimated compound annual growth rate of roughly 15%.
Amadeus was purchased in the depths of the pandemic when the world effectively stopped going on planes. Things have gotten better since then. Its share price performance primarily reflects the strength of travel spending – and general bullishness around it. But there is much more to be positive about than travel rebound: The difficulties created by COVID showed just how much Amadeus’ is stronger than its competition. The company was able to sustain and execute important R&D and infrastructure projects and deliver new solutions while peers struggled to stay afloat. The new solutions, particularly in Air IT, had strong customer adoption underpinning very high return on investments. Amadeus’ competitive advantages are increasing.
What detracted from performance?
Deutsche Böerse was a detractor in the quarter. There were two drivers. Firstly, on May 16th, Deutsche Boerse announcement of acquisition of SimCorp A/S for $4.4B. The deal was judged as ‘fully priced’ by the typically cheerleading sell-side commentators. The second was due to a decline in market volatility. Volatility and uncertainty drive a lot of capital markets activity, such as hedging. The partial decline in inflation drove lower volumes mainly in equities and equity derivatives. It is noteworthy that all asset categories in the trading and clearing business saw increases, including interest rate derivatives, commodities (power, gas, etc…) and foreign exchange. This suggests that equity related markets behavior reflected a perception of lower volatility while non-equity related markets did not. The company remains a top ten position.
AbbVie is a major biopharmaceutical company with leading franchises in immunology, oncology, neuroscience, eye care and women’s health. Through Botox it also owns the number one medical cosmetics brand. AbbVie is facing a challenging 2023-2024 due to negative sales expectations for its leading drug Humira, which was once the world’s best-selling drug, but now facing biosimilar competition due to lost patent exclusivity earlier this year. However, this has been factored into revenue estimates, and the company has a strong long-term outlook driven by a solid pipeline that provides upside optionality and able to offset a significant portion of Humira’s revenue losses in coming years with new drugs, including Skyrizi and Rinvoq that can be thought of as Humira’s improved replacements. Management is in the process of commercializing these two drugs and expanding approved indications with targeted peak sales exceeding those of Humira by 2027 (>$21bn). AbbVie remains a highly profitable and cash generative business, with undemanding valuation and offers an attractive dividend yield of more than 4%.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
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This document may contain forward-looking information which reflect our or third party current expectations or forecasts of future events. Forward-looking information is inherently subject to, among other things, risks, uncertainties and assumptions that could cause actual results to differ materially from those expressed herein. These risks, uncertainties and assumptions include, without limitation, general economic, political and market factors, interest and foreign exchange rates, the volatility of equity and capital markets, business competition, technological change, changes in government regulations, changes in tax laws, unexpected judicial or regulatory proceedings and catastrophic events. Please consider these and other factors carefully and not place undue reliance on forward-looking information. The forward-looking information contained herein is current only as of August 2, 2023. There should be no expectation that such information will in all circumstances be updated, supplemented or revised whether as a result of new information, changing circumstances, future events or otherwise.
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