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A boom in stocks associated with artificial intelligence led developed markets higher. The NASDAQ index rallied over 29% and undervalued Japanese shares rose 27%. The Australian dollar fell.  Commodities like thermal coal (-67%) and nickel (-41%) fell on a softer outlook. Bond yields closed flat after swinging wildly.

 

Market turbulence reflected the impact of higher interest rates. Silicon Valley Bank and Signature Bank both failed as tighter funding conditions effectively ran their coffers dry. Credit Suisse and First Republic Bank both required rescuing from UBS and JP Morgan.

 

Growth rates in Europe and China underwhelmed in terms of expectations. Japan was a potential bright spot, where pay increases of 3.8% were the highest in 30 years! Full employment across economies is underwriting economic growth for the time being as interest rates rose at the Federal Reserve (5.25)%, the European Central Bank (3.5%) and in Britain (5.0%). St Louis Federal Reserve president, Bullard, saw the US labour market as ‘very, very strong’.

 

Economic growth in Australia is slowing to a low pace as higher interest rates and prices catch up with consumers. Wage increases without gains in productivity is stoking inflation. The magnitude of these increases caught the Reserve Bank by surprise leading to four 0.25% interest rate increases and a cash rate of 4.10%.

 

The Beanstalk Balanced Portfolio rose over the six months, gaining 3.9%.  Australian shares accounted for half of this advance. International shares and the bond portfolio were additional contributors to returns.

 

Australian shares contributing to performance included Adbri Limited (+1.5%), AGL Energy (+1.3%) and Sigma Healthcare (+0.7%). Australian shares detracting from performance were The Star Entertainment (-0.8%), AMP (-0.6%) and Australian Vintage (-0.5%).

 

The February reporting season revealed corporate outlooks that were, on balance, below expectations. Companies that disappointed the market were punished. For example, Domino’s Pizza fell 24% and Downer Group declined 24%. Margins were supported by price increases and cost measures. Another positive feature for the period was the increase or maintenance of dividends.

 

The August reporting period is expected to demonstrate a heightened mix of growth rates across industries. Companies exposed to the consumer will generally face headwinds. On the other hand, businesses operating in the travel industry, like Qantas, are expected to do well. Government and mining expenditure is likely to produce robust results in the commercial and infrastructure areas of construction. An easing of covid-related supply lines should release capital from businesses and support cashflows for shareholders.

 

Growth, inflation and financial stability will be key challenges confronting investors in the year ahead. Goods inflation has been transferred to services inflation which is evident through the increasing momentum in wage claims. In turn, these price pressures are forcing central banks to react by increasing interest rates. Slower growth is unfolding, and, as we saw amongst regional bank failures in the US, financial stability is a focus.

 

The likelihood of higher interest rates puts into focus assets such as high growth shares. These amazing companies of the future, such as Microsoft, whose value and cash flow resides well beyond the next three years, must now compete for capital against rising risk-free government interest rates and higher long-term bond yields.

 

Artificial intelligence (AI) has been a boon for some technology companies like Microsoft. A great company, Microsoft has increased its shares price 11 times since 2012. The level of its share price indicates that investors expect its operating profit to increase 8 times over the coming decade. In the past, operating profit has increased less than 4 times. Even if the market is correct and AI does deliver Microsoft returns well beyond historical records, the impact on the value of these future cash flows in an environment of higher inflation and interest rates should be considered.

 

The portfolio seeks to protect returns from inflation through stock holdings whose value is represented by imminent or near-term cash flow and not a promise of future untested cash flows. These positions are largely assembled with long-term capital preservation in mind. Holdings reflect investments that represent outstanding value, with defensive balance sheets and often in industries starved of capital for some time. These characteristics suggest a return of pricing power and a beneficial investment status in an inflationary environment.

 

The portfolio retains a growing defensive posture with 35% of assets in bonds or cash-related positions. Over the past year, the portfolio has moved from a zero weighting in bonds to an 8% holding. For the same period, exposure to commercial property has been reduced to a very low level. Cash comprises 23% of the portfolio and is currently earning 4% pa.  A 4% exposure to sterling is adding to returns as higher interest rates in the UK increase portfolio income and demand for pounds.