Market Overview
Equity markets worldwide advanced in March, as risk appetites remained resilient amid an anticipated shift in the global monetary landscape.
With the fourth-quarter earnings season winding down, the focus was squarely on major central banks during the month, as markets awaited clues on what might come next from monetary policymakers. All eyes were on the U.S., where the latest reading from a closely watched gauge of domestic inflation suggested that consumer prices cooled less than expected for a second consecutive month in February. This discouraging news stoked fears that the progress that the Federal Reserve had made in its campaign to rein in inflation had stalled, possibly forcing the world’s most influential central bank to deliver fewer rate cuts in 2024. As expected, the Fed held interest rates steady at a 23-year high in March, marking the fifth consecutive policy meeting that it has done so. More importantly, while acknowledging the worse-than-expected inflation data the last two months, the Fed stated that the reports “haven’t changed the overall story” and signaled that interest rates were still on track to be reduced three times this year. The yield on the benchmark 10-year U.S. Treasury note ended March at 4.21%, five basis points (“bps”) lower than a month earlier.
In Europe, where the eurozone has seen inflation fall materially from its double-digit peak while its economy has stagnated, the European Central Bank (“ECB”) left interest rates unchanged at a record high for a fourth consecutive policy meeting in March. The ECB reiterated that it was making good progress in driving down inflation to its 2% target, though it was still not there yet, and strongly hinted that rate cuts may begin this summer. Similarly, in the U.K., the Bank of England (“BOE”) held interest rates steady at a 16-year high for a fifth consecutive policy meeting amid data suggesting that domestic inflation had fallen to its slowest rate in over two years and that the British economy had returned to growth in January after slipping into a shallow recession in the second half of 2023. While the BOE reiterated that it would need to see domestic inflation fall back to its 2% target and stay there before it would lower rates, it did acknowledge that “things were moving in the right direction,” fueling hopes that the British central bank may begin cutting rates as early as June. Notably, global stock markets received a significant boost when the Swiss National Bank (“SNB”) unexpectedly lowered interest rates 25 bps, its first rate cut in nine years, making it the first major central bank to retreat from its restrictive monetary policy stance during the current cycle. Investors cheered the SNB’s action, viewing it as a sign that other key central banks would not necessarily wait for the Fed to cut rates before implementing their own. In March, the yield on the 10-year German Bund, Europe’s principal safe-haven asset, fell 11 bps, ending the month at 2.30%.
While major central banks such as the Fed, the ECB, and the BOE appeared to be on the cusp of cutting interest rates, a completely different dynamic was playing out in Japan, where the Bank of Japan (“BOJ”) raised interest rates for the first time in 17 years—and in doing so, ended eight years of negative rates. The move came as Japan’s economy has displayed signs of strengthening after decades of stagnation and rapidly rising wages suggested that domestic inflation was sustainable. Notably, even after the BOJ’s action, interest rates in Japan are still significantly lower than those in other advanced economies.
The conclusion of the fourth-quarter corporate earnings season painted a mixed picture of how interest-rate headwinds have impacted company profits. In the U.S., 75% of the companies in the S&P 500 Index topped consensus estimates, which was above the long-term average of 66%. The fourth-quarter earnings growth rate increased 4.2% from a year earlier. In Europe, 43% of the companies in the STOXX 600 Index posted better-than-expected earnings, below the 55% that do so in a typical quarter. The year-over-year fourth-quarter earnings growth rate contracted 15.8%. In Japan, 53% of the companies in the TOPIX reported positive earnings surprises, which was below the 56% beat rate over the past four quarters. The fourth-quarter earnings growth rate increased 38.8% from a year earlier.
Against this backdrop, equity markets in both the developed and developing worlds advanced in March, with the former outperforming the latter. In the U.S., the S&P 500 recorded its fifth consecutive month of gains, as news that the Fed’s outlook for interest rate cuts remained intact bolstered risk sentiment. In Europe, the STOXX 600 outperformed and ended the month at a record high on optimism about cooling inflation in the eurozone and the U.K. and upcoming interest rate cuts. In Japan, the TOPIX outperformed, as investors expected the BOJ to take a cautious approach to raising interest rates. Meanwhile, in emerging Asia, the Hong Kong-based Hang Seng Index, which is comprised mostly of companies from mainland China and serves as a gateway for foreign investors wanting to put money there, lagged the broader global index, as a slew of disappointing quarterly earnings results undermined expectations for a strong market recovery. During the month, China’s central bank hinted that it was prepared to implement more monetary easing measures to support the country’s stumbling economy.
Energy was the best-performing sector in March, as shares of oil producers gained in sympathy with the rise in oil prices due to expectations that supply will remain tight as the result of OPEC+ maintaining production cuts, ongoing attacks on Russia’s energy infrastructure, and a falling U.S. rig count. Consumer discretionary was the worst-performing sector, as inflation-wary consumers remained cautious spenders of non-essential goods and services.
Outlook
We believe portfolio performance during the first quarter of 2024 showcases the merits of casting a wide net when allocating to investments in infrastructure. While a large component of our core infrastructure investment universe continued to face substantial headwinds year to date from the final stages of this present monetary policy tightening cycle, as well as lingering interest rate uncertainty, other sectors including energy midstream, railroads, and other early-cycle industrials have performed admirably.
Moreover, while share price performance in the renewable energy and clean-technology categories has been very tough sledding over the past year as supply chains normalize post-pandemic, channel inventories adjust, and anecdotal evidence mounts that there is at least some degree of slippage in the ambitious pace of capital investment as transition towards a low carbon energy future contends with competing forces, including the economics of higher interest rates, sharply lower natural gas prices, consumer affordability and customary long lead times associated with landmark legislative initiatives, such as the U.S. Infrastructure Investment and Jobs Act (“2021 IIJA”) and Inflation Reduction Act (“20222 IRA”).
On the other hand, we have also managed to find differentiated and positive investment performance contribution YTD from a number of infrastructure-related exposures in our portfolio, including engineering and construction services contractors, Ferrovial (“FER SM”) and Vinci (“DG FP”), construction materials provider, CRH PLC (“CRH US”), ride-share network operator, Uber Technologies Inc. (“UBER US”), and logistics and shipping solutions provider, Brambles (“BXB AU”).
While performance of infrastructure as an asset class, with its above average sensitivity to interest rates, has had a tough time keeping up, performance-wise, with broad-based growth equity indices year to date, the combination of defensive business models, highly predictable revenues and cash flows, and strong inflation pass-through characteristics has demonstrated commendable resilience and we find the investment category trading at considerably more attractive valuations vis a vis broad market indices.
We believe this leaves publicly-listed infrastructure equities well positioned to benefit from a continued brisk pace of investment, with plenty of runway ahead, and an end to the rate-hiking cycle, when we expect eventual lower interest rates will be used to discount cash flows that have been adjusted higher either for regulatory or contractual inflation-adjustment, or the indirect benefit of inflation adjustment that tends to stem from owning and operating high fixed cost, long life assets.
The information contained herein provides general information about the Fund at a point in time. Investors are strongly encouraged to consult with a financial advisor and review the Simplified Prospectus and Fund Facts documents carefully prior to making investment decisions about the Fund. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Mutual funds are not guaranteed; their values change frequently and past performance may not be repeated.
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Allocations and security selection are subject to change. The performance quoted represents past performance. Past performance is not a reliable indicator of future results. Mention of these securities should not be considered a recommendation or solicitation to purchase or sell the securities. It should not be assumed that any investment in these securities was, or will prove to be, profitable, or that the investment decisions we make in the future will be profitable or equal to the investment performance of securities referenced herein. There is no assurance that any securities referenced herein are currently held in the portfolio or that securities sold have not been repurchased. The securities mentioned may not represent the entire portfolio.
Equity securities will fluctuate in price; the value of your investment will thus fluctuate, and this may result in a loss. Securities in certain non-domestic countries may be less liquid, more volatile, and less subject to governmental supervision than in one’s home market. The values of these securities may be affected by changes in currency rates, application of a country’s specific tax laws, changes in government administration, and economic and monetary policy. Emerging markets securities carry special risks, such as less developed or less efficient trading markets, a lack of company information, and differing auditing and legal standards. The securities markets of emerging markets countries can be extremely volatile; performance can also be influenced by political, social, and economic factors affecting companies in these countries.
Securities and instruments of infrastructure companies are more susceptible to adverse economic or regulatory occurrences affecting their industries. Infrastructure companies may be subject to a variety of factors that may adversely affect their business or operations, including additional costs, competition, regulatory implications, and certain other factors.
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Published on April 15, 2024.