Tom O’Hara and John Bennett, Portfolio Managers of Henderson European Focus Trust, provide an update on the Trust highlighting factors that affected the European market in April and outline recent portfolio activity.
The MSCI Europe ended the month down -1.1%1, a number that masks the volatility and volume of news flow, both at the macro and micro level. What became obvious during April was that inflation would continue to track persistently higher (US headline inflation standing at 8.5% - the highest level since 19812) - meaning expectations that central banks would have to err on the side of hawkishness have now become widespread. Further, no quick resolution to the war in Ukraine is anticipated as Russia decided to concentrate its assault upon strategically important territories.
This has exacerbated already strained energy supply, a theme we wrote about in last month’s commentary: it is clear that spiralling prices and energy security remain top of mind for politicians. European gas prices remain elevated at +42% year-to-date1, whilst the increase in the oil price cooled somewhat due to the US releasing some of its strategic oil reserves and expectations of lower demand from China surfacing. The latter is something that we, alongside many parts of the market, worry about on a daily basis as China continues to pursue its ‘zero-COVID’ policy. Shanghai spent all of April in a lockdown and towards the end of the month, areas of Beijing were also put under new restrictions. This has caused further disruption to supply chains worldwide and could be a further catalyst in companies ‘near-shoring’ production to avoid over-dependence on certain countries/regions.
The last two weeks of April heralded the start of Q1 earnings season. The main theme from the companies that have reported thus far was input cost inflation being successfully passed on to customers. The industrial recession and margin squeeze that the market was expecting due to higher energy, logistics and raw material costs has proved elusive, especially in many materials names, where we are invested. This has led us to consider three potential paths forward for companies: a delay to margin compression as older, cheaper inventory is used up, demand destruction being caused by prices continuing to climb, or, more bullishly, high prices sustaining whilst input prices retreat, leading to profit margin expansion.
Currently, we have no strong conviction as to which of these options is most likely, but we believe we will start to get answers with Q2/Q3 results. Another important theme that emerged from company commentary was on China; overall, management teams were less positive in the short term due to consumer demand flailing and the construction market slowing considerably. However, many executives believe these may prove temporary due to the Chinese governments “zero-COVID” policy needing to be shifted to allow for the eventual reopening of the country’s economy. As ever, uncertainty is high, and we remain in close contact with our investee companies to best navigate the current difficult environment.
Our activity in April consisted of exiting a long-standing position in Nokian Tyres (winter tyre manufacturer with 85% of production in Russia), as well as bringing down our Banks exposure by selling out of BNP Paribas (global retail, corporate and investment bank). We opened positions in some Utilities names to capture the renewables infrastructure build-out and energy independence that European governments crave. We have also initiated a small position in ST Micro (semiconductor manufacturer) as we believe that the semiconductor cycle could trough this year.
1 Source: Bloomberg as at 30/04/2022