INTERNATIONAL EQUITIES AND AUSSIE STOCKS
International Equities Exposure
There are usually surprising developments each year in financial markets to talk about, but surprisingly (not disappointingly), 2024 appeared to be an exception, with the US stock market finishing the year on another tear, with a 25% return for the S&P500 (including dividends). This followed a 26.3% return (including dividends) in the previous year.
Who would have thought at the backend of 2022, just as we exited a long and drawn-out bear market, that this would turn out to be the best two-year showing since the two years of 1998 and 1999. Not many it turns out, but that is one of the benefits of the investment strategy we have deliberately setup and manage for you – this ‘guesswork’ is not a feature. Guesses, when combined with human emotions, typically always end up being… wrong! You don’t want to pay dearly for other people’s mistakes or emotions, and with us, you never will.
Imagine for a moment, if you will, missing out on this OPPORTUNITY.
It turned out that that our central case ‘unicorn’ soft-landing scenario we have been discussing in our quarterly reports looks to have been achieved, marking Jerome Powell as arguably one the greatest Federal Reserve Chairman’s, ever and providing a nice tailwind for global financial markets.
Indeed, using history as our guide, bull markets in the US have typically returned 66% on average in the first two years for all market cycles since 1970. Following a rise of 22% in the first year in this bull market, which commenced on October 12, 2022, history suggested that a much better year was in store for the stock market than any forecast made at the outset of 2024. The stock market rallied 33% in year two, bringing the first two-year gain to 64.43%, which is in line with the historic average of 66%. It doesn’t always work out that neatly, but it has here.
Not only did the US stock market surprise on the upside and well in excess (read: double) that of the Australian Stock Market, but the US economy did so as well.
There were concerns regarding recession in 2024 owing to a succession of 11 rate hikes by the Fed starting in March of 2022. Notwithstanding these concerns, real GDP grew at an above-historical rate of 2.7% last year with both productivity and corporate profits being on the rise heading into 2025 (we can’t say the same about the languishing Australian Economy which is barely growing corporate earnings and our political class that appears too inept to do anything positive longer-term). On top of this, core inflation has continued to fall over the year and the labour market has remained markedly resilient, a true goldilocks outcome.
Perhaps a recent surprising development was that Global equity markets faced broad declines in December, with the MSCI World Index retreating -2.7%, paring gains from a strong November. In the U.S., equity performance was mixed as market expectations for future rate cuts softened, with both the Dow Jones Industrial Average (-5.3%) and the S&P 500 (-2.5%) ending the month in negative territory, missing the anticipated "Santa Claus rally."
For those that are not aware, financial desks are typically light-on in terms of staffing and trading volumes are usually low in December for obvious reasons, especially towards the last half of the month. It’s because of this and as shown in the table below there is an enormous skew in favour of a good outcome for financial markets, that being… 75% percent of the time markets typically take advantage of the lack of staffed desks, rising on average 1.51% and the most out of all months throughout the year. It’s a true outlier.
The reason for the market to enter a take-pause mode was due to updated news whereby the Federal Reserve cut interest rates by 25 basis points and subsequently stated that the pace of cuts may slow in 2025 with potential upside inflation risks under a second Trump term. The Fed detailed that they now see their benchmark rate reaching a range of 3.75 to 4 per cent by the end of 2025, implying two more quarter-percentage-point cuts.
The bond-market however had seemingly got a little ahead of itself, baking in four cuts, i.e. another 50bps. Effectively therefore, markets had gone up strongly (too strongly) somewhat due to the incorrect adoption of a risk-free rate that was in hindsight, too low. What we saw in response was simply rates and markets normalizing to the fed speak – and hence the sharp fall in December. This marked one of the few occasions that ‘Santa’ was not able to deliver yet another positive month.
The Fed’s financial projections ultimately suggest the US economy is in good health, with economic growth forecasts pushing higher and unemployment predictions pushing lower. Goldilocks once again lives on, for now. This should continue to be welcome news for financial markets if it holds true.
This all suggests the stock market prospects for 2025 are positive, as it appears the current economic expansion will last longer, but we are always mindful that external events and shocks can curtail this view. And they often do. For example, while the recent past reflects strong performance, there are underlying challenges, particularly regarding rising US debt levels. Which to any outside observer have reached challenging levels. Much like China has faced in their economy – debt works until it
doesn’t, and the burden gets too heavy. The US fiscal position is staring at this now.
Trump and Musk appear serious about tackling this with their DOGE mandate, focusing on cutting government waste, fraud, and abuse. He only has 4 years in office, so fast policies may bring about a rise in volatility. Something we are watching out for but are powerless to prevent.
Nonetheless, 2024 has demonstrated resilience and opportunities for those of us positioned to navigate the evolving financial landscape. We were thankful we were.
CONCENTRATED PORTFOLIO EQUITY EXPOSURE
The Australian share market closed the final quarter of fiscal 2024 down 0.80%, the first negative return period for some time and attributable mostly to the 3.15% fall in December.
In the absence of any notable key news flow, and similar to the US picture, this outcome appears to have been in response to the 10 Year Bond Yield rising materially over the month (a higher discount rate = lower valuations for corporate earnings), inflicting negative market movements primarily in the materials and consumer discretionary sectors. These moves were somewhat cushioned by the relative strength in the financials and yet again… technology sectors.
It was also relatively quiet in terms of company announcements, with only our two US listed businesses (ResMed and Life360) providing financial results. Outside of this, it was literally just a scattering of other updates.
ResMed (RMD) reported an 11% increase in revenue for the first quarter of FY25 which was ahead of our forecasts. This revenue growth, paired with some significant operating margin expansion, resulted in net income growing 42% for the quarter. This result comfortably exceeded our estimates, and we saw an 8% increase in the share price over two trading sessions. Despite some broader uncertainty around the global healthcare industry, ResMed continues to provide consistent earnings growth, and we remain extremely confident in the business. It has proven to have been an excellent buy.
Your position in Life360 (360) continued on its upwards trajectory throughout the December quarter following the announcement of yet another record set of financial results in November. 360 reported annualised monthly revenue (AMR) of over $330m, up 30%. Adjusted EBITDA for the quarter was
$9m, up from $5.5m in the Q3 2023. The strong performance allowed management to increase their EBITDA guidance to $39-$42m for 2024, an 8% increase to previous guidance at the midpoint. The 360-share price increased 19% for the quarter and is now up almost 100% since taking our initial position in February.
AGL Energy (AGL) retreated 4.5% for the quarter, despite providing no market sensitive updates. We remain confident that AGL will report numbers towards the top end of their guidance range in February and still see 10-15% upside in the current share price from here. This return expectation is higher than what we believe the overall market is likely to deliver, hence we are happy to continue holding the position.
AUB Group (AUB) hosted their annual AGM in October and retained guidance for FY25 for 11-17% underlying net profit growth. We expect insurance premium growth to slow, tempering outer-year growth, but see significant room for margin improvement over the next 12-18 months as new acquisitions continue to be integrated into the business. AUB’s share price was relatively flat throughout the quarter, increasing around 1.5%.
Late in the year, we added a new position in GQG Partners (GQG), a US based funds management business into the portfolio following the announcement of Indian Conglomerate Gautam Adani being indicted in the US on alleged bribery and fraud charges.
GQG holds large positions in 6 Adani Group companies within their Emerging Markets portfolio and while the broader group describes these charges as baseless, negative sentiment in the short term often dictates negative share price movements, with the Adani Group stocks all falling between 6- 30% following this announcement. Despite owning a total portfolio position on our estimates of circa 6 per cent, GQG’s share price followed the Adani sell off, falling around 20%.
GQG subsequently provided an update provided in December which showed that investor flows into GQG products continued to be strong and we saw this as an opportunity to enter a position into a quality funds management business at an extremely appealing discount to our valuation.
It may take some time from here for water to pass under the bridge, and we expect some volatility in the short term as the fund flows shift around following the Adani incident, but we believe the long- term track record of GQG’s investment operations and reputation, put the business in a very good standing. The business is well resourced and shouldn’t need to increase costs over the next 12-24 months to sustain the higher levels of revenue, which we forecast will create high earnings growth.
This is a fundamental we are actively monitoring in their upcoming February reporting season update.
While the position is relatively small at present, we are ultimately looking to increase our weighting in GQG over the next 6-12 months as we become more confident with the business’s growth outlook.
Fixed Interest Exposure
After many years of being in the doldrums, suffering as interest rates went from an unrestrictive to a restrictive stance in a very short space of time, your fixed interest rate exposures (if any), are now delivering (from a return perspective).
Indeed, in the 12 months through to the end of December 2024, your Australian and International Fixed Interest holdings returned a decent clip as interest rates stabilised locally and, in some cases, were cut globally.
Adding to this positivity, it is the view of many, including ourselves, that investors are more likely than not to be positioned for equity-like returns in 2025 from their fixed interest rate exposure(s). This is because while the Reserve Bank of Australia (RBA) has yet to initiate an easing cycle (ditto Europe, the US, UK and NZ), expectations are building for rate cuts to commence in the first half of 2025.
In anticipation of this, we are seeing for example some Australian banks already beginning to reduce their term deposit interest rates, a development that carries significant implications for savers reliant on consistent income streams as term deposits mature and roll over. The rates able to be secured will likely be lower with the obvious implication being a shallower income stream.
In our view, after many years of waiting, an increase in investor appetite for bonds, driven by the desire to capitalise on current attractive yields before the anticipated rate cuts take effect appears to be a logical position to consider. This strategy not only offers the potential for capital appreciation as interest rates decline but also positions investors to benefit from a more stable income source.
Moreover, as inflation expectations stabilise, the inverse correlation between fixed income and riskier asset classes, such as equities, is re-emerging. This restoration of the inverse relationship underscores the diversification benefits of bonds, which can serve as a crucial buffer against equity market downturns. Something that has been absent over the past 4-5 years.
Looking ahead to 2025, the bond market appears to be presenting a compelling opportunity, marked by attractive yields, potential for capital appreciation, and diversification benefits that possibly outshine riskier and highly valued assets.
Turning back to Australia, with the December quarter experiencing a lower-than-expected Australian inflation print (2.4% CPI in Dec Qtr vs 2.8% in Sept Qtr), the credit markets have priced in a 90.8% probability of a 25bps rate cut (table below) for the RBA’s February meeting and are indicating another high chance of a further 25bps cut in May.
This is not only good news for fixed interest exposures that are exposed to ‘duration’, its also good news for interest rate sensitive sectors such as REITs, consumer discretionary, long duration stocks and banks (the latter though have well and truly already run their race).
FINAL WORDS
Happy New Year again everyone. We hope you had a wonderful break with family and friends and some much-deserved down time, recharging those batteries for the year ahead. We wrap up 2024 by simply saying that it's been a year of remarkable market movements with nearly all asset classes seeing impressive gains which have been positioned well to take advantage of.
We now head into the February reporting season with companies firmly on our wish lists, however with valuations of these companies at often-extremely inflated levels (in our view), we will remain patient to ensure we are purchasing positions that we are confident can add value to your portfolio over and above the broader index over time.
And, as always, we will keep you updated with any changes that are made within the portfolio as and when they happen.