During the month of August, the CC Sage Capital Absolute Return Fund delivered a net return of 2.68%*, outperforming the RBA Cash Rate by 2.52%. The CC Sage Capital Equity Plus Fund delivered a net return of 2.50%*, outperforming the S&P/ASX 200 Accumulation Index by 1.32%.
The S&P/ASX 200 Accumulation Index was up 1.18% for the month, with major share price moves being driven by company fundamentals during August reporting season. Company results revealed generally solid profits − impressive given the tough environment of cost inflation, supply chain bottlenecks and labour shortages. Cost increases have generally been able to be passed on through price rises and there is little evidence to suggest that consumer spending is slowing post the recent interest rate hikes. On the macro front, 10-year bond yields rose following stronger employment and wages data while the equity market gave up much of its gains late in the month after US Federal Reserve Chair Jerome Powell’s speech at the Jackson Hole Economic Symposium, where he reiterated a strong commitment to quashing inflation at the expense of economic growth.
The strongest Sage Groups^ were Resources driven by lithium and energy stocks as lithium and natural gas prices continued to soar; Global Cyclicals was driven in large part by Qantas which exited the year with very strong momentum, with lower than expected debt and an upbeat outlook for FY23; and Domestic Cyclicals was driven by a bounce in consumer discretionary stocks post reporting strong results. The weakest Sage Groups were Gold and REITs driven by higher bond yields and rising interest costs.
In our view, the extent to which interest rates need to rise to tame inflation is going to be the single most important determinant of the market direction and the composition of performance. On the bullish side, there is some evidence of peaking inflation.
As the global economy reopens, consumer spending is shifting back towards services, moderating demand for goods and taking the pressure out of supply chains. This is supported by a peak in global manufacturing indicators and a decline in the prices paid component. While the easing of inflationary pressures in tradable goods gives cause for optimism that the job is nearly done, non-tradable services inflation is high and continues to rise. This is coming from tight labour markets and strong wages growth driving cost push inflation. As US Federal Reserve Chair, Jerome Powell highlighted at the Jackson Hole Economic Symposium, near term growth will likely need to be sacrificed to get some slack back into labour markets and break the nexus between wages and prices. There are some tentative signs that the US employment market is peaking along with wage growth, but in the near term this will possibly be overshadowed by the energy crisis roiling the world. Surging gas and electricity prices in Europe are tightening supplies globally and are likely to drive a move higher in inflation through next year. While the market had a respite in July with a strong risk rally, the outlook is now more clouded with central banks seemingly willing to drive economies to battle inflation and anchor long term expectations.
On the domestic front, with interest rates higher than they have been since 2016 and continuing to rise, we are cautious on segments of the market heavily exposed to consumer spending, which is expected to fall considerably towards the end of the year. For retailers in particular, combined with the high inventory levels seen from company reports in August, a fall in demand could result in a sharp contraction in margins as companies attempt to clear excess stock. While this risk has been reflected in share price falls to a certain extent, we believe the drop off in consumer spending could be sharper than the market is anticipating, especially as incredibly low fixed rate mortgages roll off in 2023.
We remain cautious on China as housing woes persist and believe recent policy changes are unlikely to improve economic growth in the near term. There is some pick up in infrastructure activity, but even this is likely to be overshadowed by weak housing and a decline in global manufacturing from tighter policy. This is reflected in the portfolio through the underweight exposure to iron ore.
Overall, we are cautious on Australian equity market valuations for the near term, with the ASX Industrial price to earnings ratio high compared to real yields and particularly high for this stage of an aggressive rate tightening cycle. We maintain low net exposure to the Sage Groups to limit exposure to systematic macro risks while focusing on individual company earnings to drive stock selection. The portfolios as always, remains well diversified, liquid and positioned to weather the myriad of unknowns.
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