September 2022 | Monthly View

What we liked

• Australia’s unemployment rate continues to fall, down to 3.4% for the month of July – the lowest figure recorded since August 1974. While positive from an economic perspective, it does also maintain pressure on the RBA to continue raising rates as they strive to ease inflationary pressures.
• July’s U.S. inflation figure, while still high at 8.5%, represents a significant fall from the annual rate of 9.1% recorded in June and will raise hopes that inflation has finally peaked in the U.S. this was lower than market expectations of an 8.7% rise.
• A measure of broad U.S. business services activity grew more than expected at the start of the third quarter, a sign that the outlook may not be deteriorating as rapidly as analysts had predicted. July services PMI rose to 56.7 from 55.3 in June beating expectations of a 53.5 reading.
• The U.S. producer price index, a gauge of final-demand wholesale prices, decreased 0.5% in July due to a slide in energy prices. The annual increase was the lowest since October 2021 and the monthly move was the first decline since April 2020. Adding further to the view that inflation in the U.S. may have peaked.
• Chinese consumer prices increased 2.7% in July compared with the same period in 2021, the most since July 2020. Analysts expected the print to stand at a higher 2.9%. This is a benign print and a positive as it leaves policy makers with greater scope for economic stimulus

What we didn’t

• Australian consumer sentiment has fallen to a level on par with the lows of the COVID-19 pandemic and the Global Financial Crisis, according to the findings from Westpac’s monthly index. The monthly Consumer Sentiment Index fell 3 per cent in August, from 83.8 in July to 81.2. This marks a cumulative decrease of 22.9 per cent since a recent peak in November 2021.
• U.S. homebuilding fell to the lowest level in close to 18 months in July, weighed down by higher mortgage rates and prices for construction material. Housing starts plunged 9.6% to a seasonally adjusted annual rate of 1.446 million units last month, the lowest level since February 2021.
• Personal incomes and spending in the U.S. grew more slowly than anticipated last month. Incomes grew at a month-on-month pace of 0.2% in July versus consensus of 0.6% and spending or personal consumption expenditures grew by 0.1% versus consensus of 0.5%.
• Chinese retail sales grew by 2.7% in July from a year ago, that’s well below the 5% growth forecast by a Reuters analyst poll, and down from growth of 3.1% in June. This indicates continued challenges within the domestic Chinese economy, as they continue with a COVID-zero policy.
• China industrial production rose by 3.8%, also missing expectations for 4.6% growth and a drop from the prior month’s 3.9% increase.

Base Case

Our view of the most likely scenario for markets over the coming months, for which our portfolios are currently positioned.

72% Probability

The speed of global economic activity is expected to continue moderating. Despite this, we anticipate overall global economic activity to remain in expansionary territory. Slowing consumer discretionary spend and inventory builds are anticipated to be strong themes over the coming months, adversely impacting company earnings.

Potentially supporting global growth expectations is China, who we expect will accelerate to a more accommodative monetary and fiscal policy stance, to promote growth within their economy. For this stimulus to be more effective an easing of China’s COVID-zero policy is required. This is unlikely to occur until the 20th National Congress of the Chinese Communist Party takes place in mid-October. Additionally, governments of developed nations are likely to maintain moderately stimulatory policies to support long-term social objectives such as carbon reduction through energy transition and reducing social inequality.

Our view remains that inflationary pressures will continue to wane over the coming months, with the rate of increase slowing. This should be supportive for credit markets as well as valuations of growth assets and manifest in greater financial market stability. This is likely to be mitigated by earnings expectations being downgraded, as a slowing global economy combined with high input prices dampen profit margins.

Other risks remain. Those we view as most prominent include increased geopolitical tensions (U.S./China, Aust/China, Russia/Ukraine, China/Taiwan, Iran/Saudi Arabia), greater slowdown in the global economy than current consensus, faster than contemplated increases in government bond yields (due to inflationary pressures remaining elevated), a further increase of COVID-19 cases in China prolonging lockdowns and continued high levels of supply chain disruptions.

This scenario is likely to see us maintain a neutral medium-term view on growth assets. Capital preservation will be the primary objective through increased cash levels and appropriate company/sector allocations to those that benefit from the maturing of the business cycle and those that are able to maintain pricing power. This is likely to favour defensive sectors, such as healthcare and consumer staples at the expense of more cyclical sectors such as industrials, consumer discretionary and materials. Overall, asset allocation will retain a neutral to slight bias to growth assets.

Bear Case

Our worst-case scenario for the coming months, which we are prepared to position for should conditions deteriorate.

15% Probability

Global consumer demand for goods and services falls further than expected as inflationary pressures, such as high energy costs, adversely impact discretionary spending. Geopolitical tensions could act to further increase commodity prices, further exacerbating inflationary pressures. Additionally, wage pressures become more systemic as employees successfully lobby for wage increases. This will lead to a deterioration in company profits as increased input costs, increased debt servicing costs and lower demand all converge to crimp earnings.

Such a scenario would mean financial conditions are tightening while inflationary pressures remain elevated. This could see central banks continuing to withdraw monetary support at a time when the economy is unable to cope with further tightening without reducing demand and economic activity. Additionally, an untimely withdrawal or reduction of central bank liquidity could derail financial markets, which have become accustomed to liquidity support. When combined with reduced government expenditure this may cause consumer confidence and spending to fall, as prior government support is not fully replaced by gainful employment income.

Elongated supply chain issues and resultant high input costs would result in upward pressure on bond yields, particularly if judged to be more sustainable. An acceleration of bond yields from current levels could see further valuation compression in financial markets, as well as adversely impacting economic activity. This effect would be more pronounced in high valuation stocks and company’s unable to exercise pricing power.

Rapid escalation in geo-political tensions or a significant or systemic corporate default (especially due to over-indebtedness in an environment of rising bond yields) could see a liquidation of risk assets within a compressed period.

Above scenarios will see us take a more defensive position and reduce equity exposures replacing them with defensive assets, such as cash. The accelerating bond yield scenario would require a more nuanced shift toward companies and sectors that would be the greatest beneficiaries of such a move. Focus will be on a more defensive posture with capital preservation being the primary objective. A shift towards defensive sectors such as healthcare, consumer staples and utilities would combine with higher cash levels in this scenario.

Bull case

Our most optimistic view for markets over the coming months.

13% Probability

Economies across the developed world experience better than anticipated economic growth from current levels. This would lead to a synchronous global growth environment as inflation pressures wane as supply chain pressures ease, with major input costs such as energy/oil reducing. This would increase disposable income for consumers as well as reducing input costs for corporates. The result would be more resilient earnings for companies.

Fiscal support from governments would combine with sound cash levels on household and corporate balance sheets to accelerate the speed of the global economic activity. In the event central banks resume measures aimed at supressing interest rates below inflation levels, we would expect this to further fuel asset appreciation.

Such a market dynamic would see substantial improvement in economic activity globally, particularly in service-oriented businesses that will benefit from social re-opening. This would occur as demand from business and consumers combine with government and central bank stimulus measures to create a potent environment for risk assets.

De-escalation of the Ukraine/Russian war would be likely to result in increased food, gas, and oil supply from Russia. The effect would be disinflationary and reduce pressure on household budgets. This would further ease pressure on central banks to continue their path of tightening monetary policy through interest rate rises.

This scenario would be positive for financial markets as improving financial conditions act to fuel demand for growth assets in a low to negative real interest rate environment. We would act by ensuring a growth asset bias with low cash levels. Additionally, if leading economic indicators began surprising to the upside a net shift towards sectors leveraged to economic growth would occur.

Stock in Focus – Novo Nordisk

Investment Thesis

Novo Nordisk A/S (NOVOB) develops, produces, and markets pharmaceutical products. The Company focuses on diabetes care and offers insulin delivery systems and other diabetes products. Novo Nordisk also works in areas such as haemostatis management, growth disorders, and hormone replacement therapy. The Company offers educational and training materials. Novo Nordisk markets worldwide.

Key reasons for the investment:

• Strong operating performance – In their latest quarterly report NVO printed a 7% sales beat, 9% EPS beat, Additionally, they provided FY22 guidance that implied 6-10% upgrades to consensus Operating Profit forecasts. This was due to increasing demand for Novo’s GLP-1-based treatments for diabetes and obesity, which drove a significant 1Q22 operating beat and enabled Novo to raise the FY22 guidance. This result speaks to the resilience of Novo Nordisk’s suite of products. We expect this resilience of earnings to be highly sought after in the prevailing environment of economic uncertainty.
• Leverage to structural growth – Novo Nordisk provides exposure to drugs aimed at diabetes and obesity. These are two areas with above average demand for treatment. We expect this to continue, providing an attractive tailwind for Novo Nordisk’s major pharmaceutical offerings.
• Share price catalysts – Novo shares should be supported in the near term by earnings upgrades and positive Wegovy (obesity treatment) sales revisions ahead of the interim analysis of the cardiovascular outcomes trial SELECT, due in Q3 2022. The bull thesis for Novocontinues to revolve around Wegovy and the magnitude of the obesity opportunity. Despite supply constraints, weekly prescriptions in the US have risen in 1Q22, with Novo having to stop shipment of the starting doses because it is unable to meet demand.

History

Novo Nordisk’s history spans nearly a century and it all began with two small Danish companies, Nordisk Insulin laboratorium and Novo Terapeutisk Laboratorium.

After hearing of the discovery of insulin in 1921, Danish Nobel laureate August Krogh and his wife Marie, a doctor living with diabetes, were intrigued. At Marie’s urging, August travelled to Canada to seek permission from the researchers to produce this life-saving medicine in Denmark. Upon August’s return, Marie also convinced the scientist Hans Christian Hagedorn to join her husband and August Kongsted from Løvens Kemiske Fabrik. In March 1923, the first patients were treated with their insulin, setting in motion a century of innovation within protein-based treatments for people living with serious chronic diseases.

Today it is a significant pharmaceutical multinational valued at around USD$245B. The company operates in two segments, Diabetes and Obesity care, and Biopharm. The Diabetes and Obesity care segment provides products in the areas of insulins, GLP-1 and related delivery systems, oral antidiabetic products, obesity, and other chronic diseases. The Biopharmaceuticals segment offers products in the areas of haemophilia, growth disorders, and hormone replacement therapy. The company collaboration agreements with Gilead Sciences, Inc. Novo Nordisk A/S also has a research collaboration with Lumen Bioscience, Inc. to explore strategies for delivering oral biologics for cardiometabolic disease.