Global Equities

The switch, completed

Last month we told you we had begun selling long held I.T. positions at May month end and into early June, and that we had been signalling since the end of last year our intention to take the Momentum price exposure risk out of the portfolio. June is the month in which that work was finished.

The evidence is in the portfolio rather than in our prose. Technology fell from 23.2% of the portfolio to 19.2% – a reduction of almost three percentage points on top of what had already gone at the end of May. Financials rose to 18.1%, consumer cyclicals to 9.8%, health care to 5.1%, industrials to 18.3% and utilities to 5.9%. Cash finished the month at 1.34%, having been more than two and a half times that level a month earlier. We did not sell technology in order to sit on the proceeds. We sold it in order to own something else.

That distinction matters. Selling into strength and holding cash is a market call, and market calls are the sort of thing that make a manager look clever for six weeks and foolish for two years. What we have done instead is rotate the source of the return. The businesses we now own more of are cheaper, pay more, and depend rather less on a capital expenditure cycle being sustained at levels no one has yet had to fund.

It worked, which is not the same as being right

June was a good month, and pleasingly it was a broad one. Industrials contributed the most to the month’s return, followed closely by financials, with consumer cyclicals and health care both adding meaningfully. Technology still contributed positively despite the reduced weighting – we sold into a rising market, not out of a falling one. Only materials detracted to any degree, and telecoms was flat to marginally negative.

That is the shape of return we want: nine of eleven sectors positive, no single position carrying the month. Compare it with the alternative, which is a portfolio where a good month means the largest three holdings went up and a bad month means they went down. The concentration of the index in a handful of names has made that the default condition of global equity investing, and it is not a condition we are willing to accept on behalf of your capital.

For the quarter the portfolio returned 13.25% on a gross basis against 15.71% for the global developed index – the first quarter in some time in which we have not kept pace. We are entirely comfortable with that. The index outperformed because the largest stocks in it outperformed, and we had spent the quarter reducing our exposure to exactly those stocks. You cannot deliberately step away from the crowded end of the market and then complain when the crowded end has a good three months. Year to date the portfolio is up 19.97% against 12.11%, which is the more useful comparison.

What we are watching into the second half

The question we posed in May remains the question. Can the market accept the increase in capital expenditure promised by the technology companies and discounted in their P/E ratings, or will it baulk and start asking about return on capital? Our answer has not changed and our positioning now reflects it more honestly than it did two months ago: we continue to favour the picks and shovels of the frenzy rather than its promoters. Power generation, transmission and storage will require higher investment whether or not the data centre spend lives up to the most heroic forecasts. That is why industrials and utilities have grown in the portfolio and technology has shrunk.

The other thing worth watching is the long end of the curve, which caused us some grief in May and which we would expect to keep doing so intermittently. Rate-sensitive assets and the infrastructure complex will continue to be pushed around by it. We would rather own the operating businesses with pricing power than the financing structures that depend on the cost of money staying obliging.

Finally, and at the risk of repeating ourselves: it remains our central case that the best hedge for your hard earned against rapacious, fiscally incontinent governments is to hold dividend paying equities with sensible multiples, with sensible management, operating in essential areas of the economy. June’s return came from precisely that sort of business. That is more encouraging to us than the number itself.