Portfolio Update July: Rate cut speculation propels stocks to record highs

Portfolio NAV lifts 5% as equities surge on quarterly results, and the AUD weakens

With markets posting their best first half in more than twenty years, stocks entered July full of momentum. From there, a host of corporate earnings and some surprisingly strong macro data helped take indices higher, setting new all-time closing records in the process.

One of the bright spots early on was the resumption of trade talks between Beijing and Washington. And when everything is quiet, it’s perfect. When it’s not, boy do we wish this debacle would be put to bed already. We saw by the month’s end, and in recent days since, just how vital this is for markets to hold this level. Volatility is likely to remain in the short term, with an almost unpredictable ruction caused by the games.

The Trump administration’s decision to back away from plans to cut pharmaceutical rebates was a welcome (and sensible) development. It proved to be a rallying cry for the health stocks that make up the Dow Jones, with the fundamental outlook for many of them now much clearer and compelling even if markets are caught in the midst of trade angst.

However dominating headlines last month was interest rate speculation. With many, including us, forecasting a cut by month’s end, conjecture remained to the aggressiveness of the cut. Clouding this outlook was strong consumer spending and jobs data from June, as well as a better-than-expected 2.1% GDP reading in the second quarter. In the end, while the 25 basis point cut was foreseeable, the hawkishness of the panel was surprising, with dissenters voicing concerns and also suggesting we aren’t about to see a cycle of cuts.

The usual suspects shine

Between JP Morgan Chase (JPM), Goldman Sachs (GS), Bank of America (BAC) and Citi (C) the financial sector put in a solid set of earnings results. Each company notched up an earnings beat, with a string of positives overlooking a lower interest rate outlook. We think the results were solid, and financials remain a hold. Revenue growth is likely to remain stifled so accumulating isn’t our focus, however JPM, GS and BAC were up 3.8%, 7.6% and 5.8% respectively in July.

As July concluded Apple (APPL) reported an earnings beat of its own. All the more importantly, its revenue growth returned to positive territory and guidance topped expectations. We were also pleased by accelerating growth in the wearables segment offsetting a decline in iPhone revenue - a possible watershed moment. Underlying services growth was also impressive, while a reduction in Chinese VAT bodes well for sales growth.

Also producing a series of stellar reports were the tech trio of Alphabet (GOOGL), Facebook (FB) and Microsoft (MSFT). Highlights set by Alphabet were a US$25bn buyback program, lower traffic acquisition costs and rebounding revenue growth, led by excellent cloud sales.

It is pleasing to see Facebook’s data analytics misdeeds put to rest via settlement. Further investment towards privacy should not be viewed as a detracting measure if it will buoy user and advertising growth as we suspect.

Meanwhile, Microsoft’s own Azure cloud commercial segment is proving incredibly lucrative, with significant upside chasing the market leader. Other segments remain a solid base for the company’s largest capex investment in four years, which we think will translate to bottom line growth in the long run.

McDonald’s (MCD) was another favourite during reporting, reaching an all-time high as promotions helped lift same-store sales growth to 5.7%. Big investment into corporate tech and menu adjustments are also producing early results, with plenty more upside.

Elsewhere, Amazon (AMZN), PayPal (PYPL), Boeing (BA) and Netflix (NFLX) fell flat on results. Amazon revenue turned around but earnings and guidance missed as the company invests for future growth out of logistics and service improvements. We see it as short-term margin compression, for longer term loyalty and revenue growth.

A miss and lower revenue guidance from PayPal was disappointing, with product and pricing delays unforgiving. We will want to see volume for its payment app increase. Boeing’s airplane troubles led it to massive record quarterly losses as orders were pared back. There is no easy fix there, but defence spending has shown vast resilience and improvement.

Finally, Netflix lost 12.1% as its paid subscribers stalled, particularly in the US. Shifting prices higher amidst emerging competition is a big concern, and the CEO downplaying it doesn’t sit overly well with us. We’re struggling to justify the price hikes, even if stronger content is coming. At this stage its dominant position is a saving grace, but that won’t be forever.

Portfolio Performance

Last month represented a solid performance by our portfolio, with Net Asset Value (NAV) climbing 5% from the end of the first half. This accounted for the impact of quarterly advisory fees, which otherwise would have amplified our outperformance against the major indices.

In terms of the performance breakdown, roughly half of the gains in the portfolio’s NAV were from equities. As mentioned earlier, the strength in reports from Alphabet and Apple, which rose 12.5% and 7.6% respectively across the month, were significant contributors. Our shift towards financial stocks in recent months has also reaped us rewards, with the companies reporting particularly well in terms of earnings.

However, it was also some less publicised names that did well for us, with the likes of Northrop Grumman (NOC), Skyworks Solutions (SWKS), Atlassian (TEAM) and Zillow Group (ZG) all chalking up gains of at least 7% throughout the month. Looking closer at two of these companies, Atlassian is putting forward phenomenal growth numbers as it drives its revenue, so at this stage it remains a compelling stock for future exponential growth. Meanwhile Zillow Group has continued its house buying roll-out into Portland, which is just one initiative as part of the company’s strategy to build scale.

Forex also played a major role in NAV performance during July. With the USD/AUD starting July at a base rate of 1.4242, it climbed sharply higher to end July at 1.4607. The increase of 2.6% was beneficial to the portfolio given the currency movements favour our unhedged portfolio of USD-denominated stocks. At this stage the AUD remains under pressure from several sources, so more upside is at least likely in the short term, even with US rate cuts.

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