Portfolio Update August: Volatility returns as tariffs and inverted yield curve cause fear

Currency gains help portfolio NAV outperform the broader market

August marked a volatile month for US markets, with the key indices moving sharply in response to macroeconomic concerns. Amidst this was a series of quarterly results that served as a barometer for the retail sector. Ultimately, last month was the worst for markets since May, albeit it was only the second month this year that indices retreated.

There were two things on everyone’s lips during August – one, the rather unsurprising matter of an ongoing trade war, and two, an inverted yield curve.

Relations between the US and China deteriorated over the course of the month, with neither party willing to take a backwards step. Why would you when it would seem that it’s just as easy nowadays to throw barbs by Twitter and play it down when face-to-face. So much for modern diplomacy. We now have a renewed tit-for-tat campaign of trade tariffs playing out. This time the main difference is that each country’s key goods are now affected, including US crude oil and imported consumer goods from China.

American shoppers spending has been a strong point in recent months. What better way to interrupt that momentum than exposing consumers to a slug in prices! We can’t help but think this game of chicken has all the merits of a high stakes gamble, without much in the way of any actual reward. If there is any single way to undermine the US economy – rather than blaming the Fed Reserve – this trade war has all the ingredients to do the job. Which rational business would go full steam ahead with investment in this climate?

If you had never heard of an inverted yield curve before last month, then you probably weren’t alone. With the yield for 10-year Treasury bonds falling below 2-year Treasury bonds, now everyone is an expert. This signal has preceded every US recession since 1955, and is generally a sign of worry from the market about economic weakness. That said, it has mostly correlated with the times when the Fed was raising rates, as opposed to slashing them. As such we’re not concerned since the levers which can still be pulled to uphold the economy are intact, but the key will be for this damaging trade war to conclude.

A hit and miss affair

One of the market’s most trusted names in Berkshire Hathaway (BRK.A) fell shy of profit forecasts. The bellwether stock has fallen victim to trade anxieties and economic uncertainty, with such problems exacerbated by an increase in insurance claims.

After a great run this year Walt Disney (DIS) missed revenue and earnings targets, falling 4% during August. Nonetheless, added details on the company’s bundle pricing for Disney+, Hulu and ESPN+ positions it as a value proposition that should immediately begin to gather traction once it goes live. On account of this we retain our bullish outlook, accepting that heightened investment towards these initiatives could pay lucrative returns in time.

Some of the other big name stocks to disappoint investors during this round of earnings included Uber (UBER), Cisco (CSCO), Macy’s (M) and Kraft Heinz (KHC). In the case of Macy’s, their poor results and woeful outlook were hardly a surprise. Deep discounts are hitting margins, and new trade tariffs are an imposing headwind for a retailer reluctant to push price hikes onto price-sensitive shoppers. For Kraft Heinz the write downs keep on coming, while the business is also gripping with uncertainty from all angles. The two stocks crashed 30.4% and 20.3% respectively.

Alibaba (BABA) managed to edge higher 1.1% during August, paring earlier losses. The company topped revenue and earnings expectations, thanks largely to its key growth drivers like its cloud division and commerce platforms. We see the company making strong inroads beyond China’s main cities into ‘second tier’ cities, driving significant consumer growth.

The likes of Walmart (WMT: up 3.5%), Home Depot (HD: up 6.7&), Lowe’s (LOW: up 10.7%) and Target (TGT: up 23.9%) all recorded strong earnings. As we’ve said previously, it does show there is a notable difference in fortunes between the struggles of department stores, and the resilience of big box retailers notwithstanding the trade tariffs. Walmart’s e-commerce, continuing store sales and transaction volumes remain a strong point for growth, while Home Depot has focused on costs to drive efficiency. Meanwhile, the breadth of Lowe’s and Target’s offers have underpinned sufficient sales growth, amplified by strong execution.

Portfolio Performance

Despite turbulence in markets during August, our hedging strategy ensured that we were able to mitigate losses. Portfolio Net Asset Value (NAV) slid only 0.4%, considerably better than the -1.8% fall in the S&P 500.

Underlying equities performed in line with the key indices, down 1.9%. The standout stock we held amongst our positions was CME Group (CME), accounting for as much as 0.7% NAV growth. Earnings results prove the catalyst for a 12% rally across August, with macro uncertainty actually proving a tailwind for growth in the company’s contracts, clearing and transaction fees. While markets remain volatile and trading activity is higher than normal, we think it is prudent to hold a stock of this calibre, which acts as a hedge to trade concerns.

In contrast Zillow Group (ZG) proved a drag on the portfolio after Q2 earnings disappointed. Key metrics from revenue to web traffic all showed strong signs of growth. However the premier agent division appears as though its revised fee model trial will shift timing for revenue recognition. In our view this is no concern to justify the selloff.

Realised income was -0.2%. This arose from a shift out of Netflix (NFLX) due to an unclear path to profitability, emerging competition, rising costs and a decline in US subscribers. Our total unrealised income however, represents 8.3% of NAV at the beginning of August.

Currency protection contributed strongly as the USD/AUD forex rate jumped from 1.4607 to 1.4846. In turn this translated to NAV growth of 1.6%. At the end of August cash represented 1.6% of all assets, with funds deployed into new opportunities Resmed (RMD) and Roku (ROKU).

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