April was an impressive month for the Orca Global Fund, playing defence to outperform a retreating stock market by 2.4%1 . The Global stock benchmark, MSCI World Index, fell 3.0% in Australian dollar (AUD) terms, compared to -0.6%1 for the Orca Global Fund. The Orca Global Fund has now outperformed its benchmark by 5.2%1 over the last 12 months. The Orca Asia Fund was down 0.1%1 against its benchmark (MSCI Asia ex-Japan Index) for the month, and 3.7%1 ahead for the last 12 months. The Orca Global Disruption Fund was -11.6%1 behind its benchmark for the month and -26.8%1 behind for the last 12 months, with technology related stocks declining in April (-13.4% in USD terms) - the most in a single month since 2008.
Why are stock markets falling in 2022? The starting points is that stock markets had a strong 2021 and entered 2022 at a high price, so part of the story is correcting from being overpriced. The catalyst for prices falling has undoubtedly been higher inflation data than expected, with March US inflation of 8.5%, compared to a 20-year average of 2.2%. Firstly, high inflation is associated with higher costs for companies: wages, transport, raw materials, and this can crimp profit. Secondly, high inflation requires central bank action on interest rates, meaning higher mortgage costs, higher debt costs for businesses, and slower loan growth. This is all seen as slowing the economy. Adding to inflation concerns, the Russian invasion of Ukraine impacted oil prices, as well as raising political risks. Finally, in mid-April companies reported profits for the first three months of 2022, and this included consistent warnings that the market will be difficult through the rest of the year. All of these contributed to a weak stock market.
Why has the Orca Global Fund outperformed three out of four months in 2022? The Fund aims to preserve investor capital in a downturn, and so far in 2022 it has done so. The Fund invests in more defensive themes, such as healthcare stocks, particularly in pharmaceuticals, and in consumer staples stocks. In times of inflation and economic stress, we think consumers will prioritise spending on food, medicine, and necessities over Netflix and Tesla’s. Ultimately, our investment philosophy is premised on the understanding that managing the risks in a portfolio should benefit investors through the cycle of rising and falling markets.
The COVID pandemic had many unusual outcomes for the world. One of them was a rush of retail investors buying into the stock market with extra cash from stimulus packages.
Another was a shift of the economy from physical, activities, and services to online, driving up profits for technology companies. Put those two together and there was a surge of new investors buying tech stocks at any price.
From March to September 2020, technology and other disruptive themes heavily outperformed other stocks. But since late 2020, these stocks have underperformed due to a correction back in-line with the broader market, and as the economy has switched back from online to physical at a faster rate than anticipated. While the Information Technology sector did out pace most other sectors by +50% in the period starting December 2019, and a number of tech related stocks were +500%, its outperformance relative to the broader market has now considerably reduced.
To be clear, innovative investment themes are an excellent long-term strategy, but a valuation and risk overlay is imperative to deliver reliable returns. I think that the time will come this year for the Global Fund to buy back into some of these stocks. The current narrative from many stock market commentators and the media is that higher inflation is hitting technology multiples, and the sector will underperform as long as we see higher inflation. Rubbish! Higher inflation usually means you can charge more for products, and strong companies will make even higher profits, driving up share prices. There is an offset from what we call the discount rate, but inflation alone won’t derail tech stocks. Stocks suffer in inflation when they can’t raise prices without losing customers. The shift to online has seen increased competition in the sector, hurting technology companies’ pricing power. So through this period of volatility, we’ll look for tech companies which have maintained or strengthened pricing power, and who won’t lose their customers as COVID ends. Of course, the Orca Global Fund will only invest where risks are suitable, and the valuation offers attractive long-term returns.
We’re proud of the outperformance delivered by the Orca Global Fund and Orca Asia Fund over the last 12 months, and the Orca Global Disruption Fund since inception, and we hope to continue to deliver for our clients going forward. We see many interesting opportunities in stock markets at the moment and continue to believe that international stock markets offer great potential returns for investors, accounting for the risks faced.