April update

BY ERIC STURDZA

Monthly Fund Commentary
18 May 2017

BY ERIC STURDZA

As the first third of 2017 comes to end, (1) the general state of the U.S. economy, its direction, and (2) the ongoing earnings season garner attention.

(1) Since the election, President Trump and his agenda have been at the centre of the economic narrative but one must not forget that the economy has been improving for some time. As such, 2017 was already set to deliver above post-recession average real GDP growth no matter what the election outcome. Therefore, the President’s agenda actually helped by diluting downside risks (as a pro growth stance would) and by offering a potential boost to the economy’s longer term growth trajectory (especially through fiscal stimulus).

Consumer spending in Q1 was generally tempered but not worrisome. The main reason attributed was warmer weather which affected utilities consumption and ended up subtracting approximately 0.7% from the Q1 consumer spending figure. Looking forward, wage and employment fundamentals remain solid and are far from suggesting any kind of slowdown in consumer spending. Additionally, the Investment Adviser believes that a comeback from utilities is to be expected (as long as weather conditions somewhat normalise). Actually, average forecasts are already suggesting an acceleration back to above 3% consumer spending growth for Q2 17.

The employment situation is solid. The employment report released in April was also encouraging as the 211,000 figure surpassed expectations. Furthermore, the underemployment rate fell to 8.6% and the unemployment rate went down to 4.4%.

On the inflation front, the overall picture is underwhelming. Thus, it is not surprising to see the underlying narrative shift toward a more conservative stance, which the Investment Adviser would caution against. The inflation outlook since the beginning of 2017 has been strongly correlated with that of oil prices due to the easy year-over-year comps that sector is exposed to. As such, a pronounced acceleration in headline CPI in the first quarter of 2017 was almost a given. Indeed, this is what happened as headline inflation went from under 1% to approximately 3% year-over-year in a short time period. However, the correction in oil price that followed left many to believe that inflation will stall. One must keep in mind that inventory slowdowns have generally yielded oil price appreciation and since late 2015 inventories have stalled at a sub 3% year-over-year growth rate. So in other words, the Investment Adviser believes that oil prices will generally increase over the course of 2017 and as such will continue to positively contribute to the headline inflation figure.

On the housing front not much has changed in terms of the fundamental picture. There still is the view that the housing market should deteriorate in a rising rate environment due to its inherent impact on mortgage costs. However, the Investment Adviser believes that the correlation this time around is not as straightforward. If rates are raised for the right reasons and in the right conditions then generally speaking the overall improving backdrop should offset any increases in mortgage costs. Furthermore, current real estate assets compared to their replacement cost are still far from the peak observed in the last three economic expansions.

The Federal Reserve confirmed the Investment Adviser’s opinion that the employment situation is on track, the Q1 weakness in consumer spending is to be dismissed, as the fundamentals such as income growth remain sound and encouraging, and that inflation should be within the Fed’s targeted range. For now, the Investment Adviser still expects to see 2 rate hikes this year.

(2) The ongoing earnings season has generally been strong. More than 80% of S&P 500 companies have reported their results. Of these, 82% managed to beat or meet estimates led by Information Technology, Consumer Discretionary, Financials, and Health Care sectors. Market reactions have again been asymmetric even though the companies that have reported increased year-overyear earnings by +12.9%, which represents nearly double the consensus forecast before the earnings season began. Companies that beat estimates were generally not rewarded as much as companies that missed their estimates were punished. Companies that missed top and bottom line forecasts underperformed by -3.7% on average whilst companies that reported with a beat were generally muted.

For the Fund, 15 companies reported their results in April and all beat their estimates with an average upside surprise of 5.96%. In terms of stock selection Alphabet, Eplus, Cerner, Priceline, and Sherwin-Williams were the Fund’s top contributors whilst Envision Healthcare, Bank of the Ozarks, AutoZone, and Signature Bank were the largest detractors. On the allocation front, not being exposed to the Energy sector and being overweight in Information Technology helped the most in terms of relative performance whilst holding approximately 9% in cash and the Fund’s underexposure to Industrials were very slight detractors in April.

All in all, the Fund returned +0.73% in April whilst its benchmark returned +1.05%. On a year-to-date basis to the end of April, the Fund has returned +6.80% whilst the MSCI US TR returned +7.19%. The Investment Adviser is pleased to see the Fund’s holdings evolve at a well above market average pace and expects these strong performances to translate into stock price appreciation and as such offer investors an above market average return over time.

 

The views and statements contained herein are those of the Eric Sturdza Banking Group in their capacity as Investment Advisers to the Fund as of 16/05/2017 and are based on internal research and modelling.