Performance and market insights - September 2023

Market Insight
October 16, 2023

Performance summary

The CC Sage Capital Absolute Return Fund returned 1.55%* in September versus the RBA Cash Rate of 0.32%.

The CC Sage Capital Equity Plus Fund returned -2.21%* in September, outperforming the S&P/ASX 200 Accumulation Index by 0.63% which returned -2.84%.

The S&P/ASX 200 Accumulation Index fell -2.84% in September driven by a 50 basis point spike in US and Australian bond yields amid higher oil prices, an increase in headline inflation and market expectations that further rate increases by the US Fed may be needed to contain inflation. Increased Treasury issuance amidst high fiscal deficits and the expiry of quantitative easing have also been driving real yields higher.

The Sage Groups^ that were the strongest contributors to performance were Yield, Growth and Defensives with Global Cyclicals being a detractor. The key derivers for performance in Yield were long positions in QBE Insurance (ASX: QBE +5%) and Suncorp Group (ASX: SUN +2%), as insurers benefit from rising long term bond yields. Growth was driven by a short position in Xero (ASX: XRO -10%), as global technology names were hit hard especially those trading at very high valuations, and a long position in Telix (ASX: TLX +3%) on the back of positive sentiment surrounding the growth of the radiopharmaceutical industry. On the negative side, Global Cyclicals was impacted by a short position in Seven Group Holdings (ASX: SVW +12%) as the market became more positive on the growth of its major business Westrac.

Resources was the only Sage Group to finish in positive territory for the month, driven by energy stocks on the back of higher oil prices due to resilient demand and ongoing OPEC production cuts. The weakest Sage Groups were Gold driven by higher real yields, REITs given real estate valuations are highly sensitive to changes in bond yields, and Growth as the valuation of long duration cashflows is also negatively impacted by higher long term bond yields.

Portfolio positioning and outlook

The global economy has remained relatively robust in the face of tighter monetary policy. Corporates and households are displaying lower sensitivities to interest rates than would have been expected historically. With corporate balance sheets in reasonably good shape, where debt does exist, it has generally been hedged or issued at longer maturities. An ageing demographic that is net cash has been a beneficiary of higher interest rates - with a higher propensity to consume than expected. This has helped to bolster corporate profitability and has kept equity markets at near highs.

However, in recent months there has been a concerning uptick in real bond yields, emanating out of the US Treasury market. Higher primary fiscal deficits as well as an increased refinancing burden as the US Fed allows its balance sheet to unwind as bonds mature, has helped drive real interest rates not just to pre-Covid, but pre-GFC highs. As central banks globally follow the same path, it is not clear whether this process has finished quite yet. These developments carry significant implications for equity market valuations. In theory, assuming long-term real growth and risk premia remain unchanged, these valuations should be directly linked to real interest rates.

To complicate matters, the inflation impulse is likely to pick up in the short-term following the surge in oil prices. Some indicators are pointing to the end of the inventory cycle unwind that occurred following the reopening of borders and the overstocking across supply chains. A stronger impulse on goods inflation combined with higher oil prices and sticky services inflation will make it tough for central banks to give any relief on interest rates to borrowers. The combination of inflation well above target levels, a blowout in real interest and the potential for a growth slowdown, leave us very cautious on equity market valuations. The market has become more cautious on leveraged commercial property exposures and has begun selling REITs and leveraged infrastructure names, and we see a risk that this broadens across the high multiples being paid for many growth and defensive stocks.

In commodities, we remain positive on oil as demand remains robust, inventories continue to fall and production cuts from Saudi Arabia and Russia remain until at least year end. The recent resurgence in geopolitical tensions across the Middle East is also likely to build some risk premia back into oil prices. We have become more cautious on lithium stocks in the short term as supply appears to have been coming on faster than demand growth and supply chains still appear overstocked. We are more neutral on iron ore as Chinese steel production has remained reasonably robust with the aid of exports and policy easing measures.

Overall, across the portfolios, we retain a preference for stocks with strong pricing power able to drive their own growth independent of the economic cycle. We continue to maintain low net exposure to the Sage Groups to limit exposure to unpredictable macro risks and as always, the portfolios are well diversified, liquid and positioned to weather the myriad of unknowns.

Read the monthly reports for additional commentary.

* Past performance is not indicative of future performance. ^ Sage Capital uses a custom grouping system for long short positions (Defensives, Domestic Cyclicals, Global Cyclicals, Gold, Growth, REITs, Resources and Yield). With a focus on the principal macro earnings drivers for each stock, Sage Groups allow for comparisons to GICS for selecting stocks within a sector.