What just happened? – A look back at the year so far

In this latest podcast, we ask “what just happened” in the first half of 2023 and what did we learn as investors? Whilst there were quite benign returns in sterling terms, underneath the surface there was plenty of drama with a reversal of what happened in 2022 – tech roared back strongly from its lows and the 2022 winners like oil and gas resumed their longer-standing underperformance of recent years. After something of a frenzy in May and June, and associated predictions of the end of the world as we know it, is some of the hype surrounding AI now abating – and what does that mean for markets?

JL: Hello, and welcome to the 17th and latest instalment of Connected Investor, the podcast from the Brunner Investment Trust. I'm Joe Lynam, the BBC presenter and Newstalk business editor. And in this podcast, we're going to ask “what just happened” on the markets in the first half of this year. And we've touched on the hype and hysteria of artificial intelligence and its relevance for investors and, of course, for the Brunner Investment Trust. I'm joined by the co-leads of the Brunner Investment Trust, Christian Schneider, but also Julian Bishop, who is now the co-lead also of the portfolio. Julian and Christian, hello to you both. Can I start with you, Julian, if I may? We're now well into H2, or the second half of the investment year. Can we in any way sum up what we learned in the first two quarters of the year and what it meant for Brunner?

JB: Yes, sure. First of all, let me just mention that Brunner has a peculiar year-end. So, we have a November year-end, so the first half for us goes to the end of May. And we've just done a lot of work for our interim report just describing what happened in the first half of the year. I think how I would summarise the first half of global markets generally is one of pretty benign returns. So, quite modest returns, in sterling terms. But, under that there's been a lot of drama. So, we saw a reversal, really, of what happened in 2022. So, tech, which have been very weak in 2022, roared back very, very strongly. And a lot of the things that had led in 2022, so oil and gas names, financials, resume their long-standing underperformance and that was attributable to a fresh bank crisis in the States, with Silicon Valley Bank, and then much weaker commodity prices. So, we've seen oil prices fall, you know, 20% to 30% from their peak and European gas prices now down 80% year on year. You mentioned artificial intelligence. I think if we look at the tech markets, three things happened really. First of all, in 2022, valuations went down a lot as prices crashed back down to earth, so we got to levels where valuations were a bit more attractive. We also saw interest rates stabilise and interest rates tend to have a disproportionate impact on the calculations, when you calculate the present value of a growth stock. So, tech stocks tend to get a bit more impacted by higher interest rates. And then thirdly, this new narrative around artificial intelligence provided the market with a new story. And if there's anything tech investors like, it's a good story. And that was seen in droves in Q2, after a spectacular set of results from a tech company in the States called NVIDIA.

JL: A lot of issues in there to unpack, Julian, can I come to Christian and ask him about that NVIDIA issue? It has joined the trillion-dollar club. Is that a direct result of the AI boom? Or are there other reasons why NVIDIA has boomed?

CS: Yes, mainly that, we think. Clearly, I mean, if you look back six, seven months from here, at the time nobody would have guessed that tech comes roaring back so quickly and so massively, but as Julian just highlighted, there was a massive impetus from this, this focus on AI which started to look just before Christmas, when ChatGPT came into focus. And clearly NVIDIA, as the kind of main provider of GPUs, graphic processing units, that do most of the heavy lifting in terms of processing the AI tools out there, kind of being seen as one of the main beneficiaries of whatever AI brings to the world, ultimately. So, it clearly needed this, this kind of impetus. But you saw strength across the board and tech land from six, seven months ago, and it was a surprise, and to a large degree, that has also to do, and was further boosted by, the lack of further increases in the 10-year yields, which basically stagnated since October last year. And, so that kind of headwind we saw 2022, mainly 10-year rising and the risk-free rate rising, kind of disappeared. And the market again, focused on fundamentals of those tech companies which are across the board actually quite sound. And the same is true for NVIDIA, of course.

JL: Then I go back to Julian, and I'm assuming right now, Julian, that you are not artificial, that you are not an avatar, that you're actually there. Wave if it's you? Yes, okay. It's you. Now, AI has been predicted that it could even spell the end of humanity, as we know it. I mean, obviously, that's a bit hysterical. But some very, very senior people, including bosses of AI developers, wrote that famous letter in the springtime. We're now well into the second half of the calendar year, is that hype kind of abating?

JB: Well, the share prices are still going up, generally. I think things have stabilised a little bit since the frenzy in May and June. But yes, share prices for large-cap tech across the board are still pretty elevated. NVIDIA has been in a little bit of a league of its own because it's seen as this pure play on AI. But that enthusiasm for tech has been across the board and these large tech companies. So, Apple, Microsoft; Microsoft is the biggest holding and Brunner, Amazon, etc, have all participated in that. And they're absolutely enormous companies now, I mean, that's the key thing to emphasise, you know. Apple is a $3 trillion market cap company. So, it's bigger, individually, than the entire UK stock market. So, it's considerably more valuable than the FTSE 100, for example.

JL: Astonishing. I wonder whether that says more about the UK stock market and companies de-listing than it says about Apple?

JB: Partially, but in itself, it's just a vast sum of money, you know, and if you work in finance, you get used to billions, now trillions of dollars. But by any standard of the imagination, by any stretch of the imagination, Apple is absolutely vast. And what we're seeing, as well is a unique concentration of the US stock markets. And now the biggest five US companies are worth about 25% of the entire S&P 500. And we've never seen anything like that before. And, you know, normally as a global investor, you don't really have to think about the stocks that you're underweight. But more and more you do have to have to do that. And, Christian and I have been having some conversations, you know, recently about these very large companies that we don't own. But the good news is, you know, in the first half, despite this shift to mega-cap tech, we did keep up performance-wise. So, we were up 1.3%, relative in the period; our dividend went up 8% year-on-year. So, we are keeping up with this market. But, our holdings tend to be a little bit, with the exception of Microsoft, a little bit further down the market cap spectrum. And we think offer, on balance, better value.

JL: Christian, I'm going to bring you in and ask you whether things might change, now in the second half. Or whether you think tech companies might be approaching a bit of over-valuation, given what they've seen over the last eight months.

CS: As you know, kind of short-term market direction guessing is always very difficult. As I said earlier, in my first answer, who would have guessed six months ago, that tech comes roaring back. So, who am I to tell whether the next six months look different? But you're right, clearly tech stocks have regained some valuation premium in the last six months. So, while fundamentals have been great for them, also, there was a significant re-rating in the last six months on these names. And, one has to keep that in mind. And clearly, at these levels, those stocks are more at risk, if any sort of correction in global multiples would approach. Triggered for example, by more rate hikes or anything, just bringing up a possibility here, but that clearly is a risk for these names, absolutely.

JL: Now, Julian, let's move tack a little bit and move into the kind of, the bigger macroeconomic situation. We saw a huge spike in interest rates in all the major stock.

We saw a huge jump in interest rates in all the central banks, the major ones that we focus on here in Europe and North America. The question now for the second half is when do they pause? When do they reach the top of the ladder, do you think? And, how long they will stay at the top of the ladder? Because, I mean, if you had asked me, three, six months ago, people will be talking about whether the Fed, for example, would be lowering interest rates in the second half of 2023. They're not talking about that now.

JB: No, no. I mean, we don't have a crystal ball, we tend to be more focused on bottom-up stock specifics, but nevertheless, I can try to address your answer. I mean, the reality is in the UK that inflation is proving to be very stubborn. So, I think the print for May, the core inflation figure, which excludes volatile food and energy was up 7% year on year, and that's a couple of percent higher than it is in the ‘States. So, it's more of an issue in the UK, you know, hence, the Bank of England, just raising rates from four and a half to 5%. And obviously, with time that will feed through into people's mortgage prices. So there's obviously a pretty bleak outlook, I think, in the short term anyway, for the UK consumer. I think in the ‘States, inflation there seems to be coming down a bit, a bit faster. And certainly, if you think about all this sort of leads into inflation, I think the news is going to get better from here, going forward. So, I mean, we mentioned earlier, some of the commodity price declines that we've seen. And now if you look year on year, most commodities are down. There was also in the UK, in the US and in Europe, over COVID a lot of money flushed into the economy, you know, so huge spike in M2 (a measure of money supply), basically, helicopter money, so people paying people not to work during COVID. So, these stimulus payments, which were probably sensible and the ethically right thing to do, but effectively paying people to do nothing is as close as definition so helicopter money as you're likely to find. And I think that had a strong inflationary impulse.

JL: Especially since a lot of people hoarded money, since they couldn't fly and go on holidays, and maybe they couldn't do that extension that they wanted to do. So, they hoarded money, and then that money was unleashed, Christian in 2022 and now in 2023.

CS: Yes, absolutely. There is clearly a demand overhang in the economy. So, too good of an economy from this money lurking around, and people coming out and spending it, simply. And the goal by central banks is clearly, with interest rate rises, to cool off demand in the economy. Cool off the speed of growth in the economy, hence, and so far, surprisingly, there is less damage to economic growth than central banks would have thought / hoped for. And while interest rates, sorry, inflation is coming off a bit, as we speak, the big question is whether we reach the target zone for central banks, around 2%, any time soon, or whether they have to keep on fighting inflation for longer. But to Julian's point, the US looks closer to this point than we are over here in Europe and the UK.

JB: So, it's essentially bankers’ unenviable task, really, to get the economy to slow, that's their job. And they've done that and GDP growth on both sides of the Atlantic is very close to zero. So, they're succeeding in that task, which is not one which I envy, frankly.

JL: Christian, can we finish with, with the investment kind of strategy and procedure for Brunner? Do you kind of look at a small number of companies; invest in them? Or do you look at a much wider portfolio to kind of spread your risk.

CS: Of course, risk diversification is an important point for every investor. Don't put all your eggs in one basket, as people say. And in forming the portfolio, building the portfolio, we'd rather try to make 60 single bets on single companies and their future progression and rather than making one big binary bet, on, say, what interest rates do, what the GDP is doing. Because the former is a much easier task and puts us at less risk of failure in our estimates.

JL: So, thank you very much, Julian and Christian; the portfolio co-managers of the Brunner Investment Trust. That's all the time we have for this episode of The Connected Investor. And thank you for joining us. Don't forget to subscribe to Connected Investor wherever you get your podcasts. You could also leave a review and give us a rating so that we can learn for the next time. That would also be great. You can also send messages to us via the website, that is www.brunner.co.uk. From Christian Schneider and Julian Bishop and from me, Joe Lynam, ta ta for now.