CIO Insights: A bumpy start to 2022


Hi everyone
Welcome back to the Hearts and Minds Investments engine room for 2022!
Despite the spread of Omicron, I hope you’ve had a chance to rest up, see your loved ones and are keeping to some of the New Year’s resolutions we make every year.
For a while in early December, it looked like we might get what has become known as the “Santa Rally” in equity markets, this time we most certainly have not seen that. Indeed, it has been one of the worst starts to a calendar year that I can remember. I’ll get into this a bit more in a moment though.
As you would most likely be aware, we publish the company’s net tangible assets (NTA) estimate to the ASX every Monday, on three levels: Pre-Tax; Post-Current Tax; and Post-Tax. I’ve written about the differences between these in a previous note, but I’ll do a refresher in the coming weeks.
This week’s numbers showed a peculiarity however, whereby the pre-tax NTA was equal to the post-current tax NTA.
How is that so? The previous weeks numbers were $3.92 and $3.80, while this week both numbers were $3.78. The reason for the 14c drop in pre-tax vs 2c decline in post-current tax is that we paid a tax instalment out of our cash holdings. This reduces the pre-tax number but not the post-current (or post-tax) number. This is relevant because many people look at the pre-tax NTA changes as a proxy for the weekly investment return of the portfolio. As you will now appreciate, the fund did not decline 3.5% for the week, but rather a 0.5% decline. So, when looking at performance, either the post-current or post-tax weekly change will give you a better guide to weekly investment performance.
In saying that, the post-tax NTA is about 5% lower than a month ago. What is going on with these markets I hear you ask! Why are they getting hit so hard, when it looked like economic growth was solid, employment was back to pre-pandemic levels, and companies were supposedly delivering solid earnings?
Everyone fears inflation is back. It’s that simple. The supply chain disruptions we’re all seeing in our everyday lives, caused by staff not being able to work while they isolate (along with family members…I’ve had to do it, have you?) is coming through via increased prices for goods and services that are available. I got talking to the owner of a café nearby, and he told me that instead of paying $30/box for his regular order of asparagus, he is now being charged $85/box. Ouch. Right now, no one knows how long the inflation we are seeing will last. It could be six months; it could be years. Only time will tell.
The way markets work though, is that when the inflation ‘genie’ is out of the bottle, people talk about interest rates going up. You’ve no doubt seen the media talking about how three (or even four) rate rises are coming in the next 12 months over in the United States. People speculate that the Reserve Bank will also raise rates, despite previous talk about “no rate rises until 2023/24”. Again, only time will tell.
Rising interest rates are generally not great for equity markets, for the simple reason that companies are valued by discounting their future earnings estimates back to present day dollars, and a higher discount (interest) rate lowers a company’s theoretical value. So analysts are releasing updated models showing many companies to be worth less than they were a week ago.
This is more noticeable for those companies that don’t have much in the way of current earnings but expect to make substantial profits in the future. Do the maths for yourself ($100/1.02 = $98.03; $100/1.03 = $97.08), and it only becomes more pronounced the further out in time you go. And this is where a lot of technology companies expect to start earning profits – five years and beyond. I was shocked this week when I read that 40% of Nasdaq companies are currently down more than 50% from their 52-week highs, even though the Nasdaq itself was near its all-time highs just a few weeks ago. This is because just five stocks, and you’ll have heard of them: Apple, Microsoft, Google, Tesla, and Nvidia; account for more than 50% of the index gains since April.
So, what volatile times we find ourselves in. The big tech stocks that have solid earnings are holding up quite well, while up-and-coming tech stocks have been hit really hard. Mining stocks have been strong, with commodity prices rallying, while banks have held up pretty well since they also tend to fare better in a higher interest rate environment. As you know, our portfolio holds companies in each of these categories, and we continue to monitor our holdings with our managers closely.
With earnings season yet again upon us, we look forward to the latest reports of the financial health of the companies we hold, and how they view the outlook for the rest of 2022.


Stay safe

Rory Lucas
Chief Investment Officer
Hearts and Minds Investments Limited

Reminder: these are simply my general views and should not be taken as investment advice


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DISCLAIMER: This communication has been prepared by Hearts and Minds Investments Limited (ABN 61 628 753 220). In preparing this document the investment objectives, financial situation or particular needs of an individual have not been considered. You should not rely on the opinions, advice, recommendations and other information contained in this publication alone. This publication has been prepared to provide you with general information only. It is not intended to take the place of professional advice and you should not take action on specific issues in reliance on this information. Past performance is not a reliable indicator of future performance. This document may not be reproduced or copies circulated without prior authority from Hearts and Minds Investments Limited.


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