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Spring has sprung!

The Hosking Partners portfolio saw another positive quarter of returns. This performance builds on recent strength, taking gross portfolio returns over the past three quarters to 20.9% versus 16.0% for the MSCI ACWI (in US dollar terms). The absolute and relative returns speak to a shifting of the investment sands. It would appear we are now at “the beginning of the beginning” of the long-awaited momentum unwind.

That the portfolio’s positive performance came notwithstanding the drag of the c.20% underweight to North America underlines this view. Encouragingly, the negative effect of the underweight to North America was more than offset by contributions from Japan and the Emerging Markets. Comprising a historically high two-thirds of the MSCI ACWI, the US market remains – for now – the centre of the investing world, especially in light of the dominant AI narrative. Despite this powerful technology thematic, we take solace from the increasing dispersion of shareholder returns among the dominant large cap US tech companies. Our longstanding zero weight to Apple (discussed in our last quarterly update) was, for the second time in three quarters, the largest single-stock contributor. That Tesla (also zero weight) was the second largest single stock contributor underlines the impact of index concentration unwinding. We watch the unfolding EV movie with interest, it is possible that Tesla has peaked in share price terms at the exact moment when the massively over-capitalised Chinese EV industry has started to export its glut of surplus vehicles. Stellantis CEO Carlos Tavares has referred to the situation as a competitive ‘bloodbath’. As capital cycle investors, focused on the supply side of industries, we have sympathy.

Whether the remaining Magnificent Seven companies are at such a risk is debatable. In a recent call with Empirical Partners, it was noted that in 2023, 50% of all S&P500 capex was deployed by just these 7 companies. The remaining 493 companies account for the remaining 50% of the index’s capex. It is clear that the Magnificent Seven are increasingly not ‘capital light’ businesses. As they move to compete in cloud, data centers and AI, their returns are, all else equal, likely to be pressured. This is the case in China, where the large tech companies compete head on in areas such as cloud and where valuations, for a variety of reasons, have collapsed.

The renaissance of the Japanese stock market continued. Despite a 6.8% fall in the yen, MSCI Japan rose 11% in US dollar terms. The basket of over 50 Japanese names within the portfolio added value with a number of our small cap and activist-inspired investments seeing significant corporate activity. Whilst the pace of Japanese purchases slowed considerably in the quarter, with just two new single stock additions, we see significant latent value in our holdings particularly as industrial consolidation – a key part of the Japan value release puzzle – becomes a reality. Elsewhere, on a sector basis, the largest positive contributor was financials, while our exposure to memory semiconductors, stood out amid the portfolio underweight to IT.

It was gratifying to see a number of our idiosyncratic smaller cap shares make substantial contributions to the overall portfolio return. Our basket of nine Sri Lankan names rose c.17% in US dollar terms over the quarter. The Sri Lankan economy grew 4.5% in Q4 2023, the first positive quarter since the Covid-era economic crisis and subsequent IMF program. With tourism numbers increasing month by month, the investment outlook is bright, with foreign institutions still largely absent. Indeed, Hosking Partners was the largest institutional participant in the Sri Lankan stock exchange during 2023.

Detractors for the quarter came in the form of the underweight positions in notable US growth stock performers. At the sector level, our mining companies remained under pressure for much of the quarter. The debate over the Chinese economy and the CCP’s ability to deal with the deflation of a housing bubble continues, with commodity prices particularly sensitive to newsflow around any potential stimulative measures. Regular readers of these reports do not need reminding that our mining investments are predicated on supply curtailment and not speculation regarding China demand.

Turnover was c.2.8% for the quarter, with notable purchases in emerging markets and the mining sector. These included a new position in an Indonesian financial, Indian gold-loan company, and a Turkish warehouse operator that Django Davidson and Omar Malik met during a trip to Istanbul in October 2023. Mining investments saw additions to the copper basket where we see encouraging signs of our supply constrained capital cycle thesis playing out as described in our Copper Capital Cycle Hosking Post of March 2023. Whilst our investment thesis in copper is supply predicated, we recognise a clear benefit for copper should some of the more aggressive AI demand forecasts materialise. For instance, JP Morgan estimate that each 1 MW of data center power capacity requires 20-40 tonnes of copper, which would add up to 5 million tonnes of additional copper demand by 2030, equal to nearly one-fifth of annual primary copper supply.

The portfolio activity underscores a long run portfolio trend; the recycling of the portfolio’s assets from cyclical ideas that have matured into situations where the opportunity lies ahead. Overlaid with a geographic skew that has seen the portfolio re-orientate from the expensive US market into lowly-valued emerging markets, Japan and Europe. This process has been a decade-long work in progress. These actions take advantage of those variables under our control and have led to a portfolio that has halved in value versus the index over the past decade.

Portfolio P/E relative to index (1)

This is relevant as we believe that we have avoided (or perhaps more accurately not participated in!) the major market excesses of the past decade. The period of normalisation is likely to take many years. The emerging outperformance of the portfolio feels like the arrival of Spring for long-term capital cycle investors. There will still be the occasional cold night ahead, but we are off to the garden to tend to the sweet peas.

1 - Hosking Partners, FactSet. Representative portfolio as at 29 Feb 2024.  Index is the MSCI ACWI Index.

31 March 2024

Q1 2024 - Quarterly Report Commentary

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