Jeff Sayer: This is Jeff Sayer, Portfolio Manager of the Ninepoint Global Infrastructure Fund and the Ninepoint Global Real Estate Fund. Welcome to our 2022 mid-year review.
With the S&P 500 closing at 3,785 on June 30, the best gauge of stocks in the United States finished the first half of 2022 officially in a bear market. Down 20.6% year-to-date and trading at 16.3x 2022 consensus estimates and 15.2x 2023 consensus estimates (according to Refinitiv), fear regarding an impending recession has gripped investors. Broadly speaking, the first six months of 2022 has been the worst start to the year since 1970 and the pain has been even more severe in the unprofitable but high-growth sub-sectors of the market. The combined impact of the Covid-19 Omicron variant, additional lockdowns in China and the Russian invasion of the Ukraine has exacerbated inflationary pressures and weighed on global growth, triggering the market selloff.
As has been the case all year, investors have been fixated on inflation and the ensuing path of future interest rate hikes. The May CPI print (released on June 10) was particularly troublesome for the equity markets since it essentially negated the argument of transitory inflation. The report showed an increase of 8.6% over the last twelve months and 6.0% over the last twelve months excluding food and energy, a slight increase from the 8.3% headline number for April and a slight decrease from the 6.2% core number for April. However, the details of the report indicated that some of the categories that had been deemed transitory (such as gasoline, used cars & trucks and apparel) and had seen price declines over the past month or two suddenly reaccelerated to the upside.
The concerning data forced a quick response, so after the Fed’s 50 bps interest rate hike on May 4, the FOMC moved 75 bps on June 15 to a range of 1.50% to 1.75%. The official statement, summary economic projections, Powell’s press conference and various subsequent speeches suggested that another 75-bps interest rate increase should be expected, and they delivered on July 27, with the current range now 2.25% to 2.50%. Beyond July, the futures curve is currently pricing additional hikes at the September, November and December FOMC meetings, implying a Fed funds rate of approximately 3.25% to 3.50% by December. Given the negative sentiment tied to rising inflation expectations, investors will need to see clear evidence that inflation is moderating before tempering rate hike expectations.
Although most of the year-to-date market decline could be attributed to multiple compression due to rising interest rates, investors have understandably started to question forward earnings expectations in a deteriorating economic environment. Thus far, consensus estimates have been reasonably stable around $230 for 2022 and $250 for 2023, but the threat of slowing growth and margin compression does pose a significant market risk. Theoretically, if we do see a challenging Q2 earnings season with materially lower guidance for the second half of 2022 and the full year 2023, we could experience a negative earnings revision cycle, which would likely represent the final phase of the equity market drawdown. We could then finally begin to look beyond the trough, to potentially easier monetary policy and earnings reacceleration going forward.
Year-to-date to June 30, the Ninepoint Global Infrastructure Fund generated a total return of -3.1% compared to the MSCI World Core Infrastructure Index, which generated a total return of -3.7%. Top contributors to the year-to-date performance of the Ninepoint Global Infrastructure Fund by sector included Energy and Information Technology while top detractors by sector included Industrials, Real Estate and Utilities on an absolute basis. On a relative basis, positive return contributions from the Utilities, Energy and Information Technology sectors were offset by negative contributions from the Industrials and Real Estate sectors.
We are currently overweight the Energy sector, market weight the Real Estate sector and underweight the Utilities and Industrials sectors. With inflation remaining elevated and growth slowing, our work has been focused on both the Energy sector (our largest relative overweight for valuation) and the Utilities sector (our largest absolute weight for defensiveness).
Year-to-date to June 30, the Ninepoint Global Real Estate Fund generated a total return of -22.2% compared to the MSCI World IMI Core Real Estate Index, which generated a total return of -19.4%. Top contributors to the year-to-date performance of the Ninepoint Global Real Estate Fund by sub-industry included only Internet Services & Infrastructure while top detractors by sub-industry included Industrial REITs, Residential REITs and Specialized REITs on an absolute basis. On a relative basis, positive return contributions from the Real Estate Operating Companies, Diversified REITs and Office REITs sub-industries were offset by negative contributions from the Industrial REITs, Residential REITs and Specialized REITs sub-industries.
We are currently overweight Specialized REITs, Industrial REITs and Residential REITs while underweight Real Estate Operating Companies, Diversified REITs and Diversified Real Estate Activities. Although the Industrial REITs have experienced a meaningful pullback, the outlook remains positive for warehousing, distribution and logistics assets. Our analysis has also been focused on other sub-industries with the greatest potential for margin expansion, including potential opportunities in the Specialized REITs and Health Care REITs sub-industries.
Given an investment environment characterized by moderate inflation and slowing growth, it is not surprising that infrastructure has outperformed but it is somewhat disappointing that real estate has underperformed. Despite both asset classes offering a nice combination of inflation protection and income generation, investors have gravitated toward infrastructure but have shied away from real estate based on fears of a looming recession. However, the fundamentals of most of the underlying businesses have been steady, and the dividend yields remain attractive, so we should expect better relative performance from both sectors over the balance of the year. In the meantime, we will continue to apply our disciplined investment process, balancing valuation, earnings or cash flow growth and yield, in an effort to generate solid risk-adjusted returns over the cycle.
Thank you for your time and support.
1All Ninepoint Global Infrastructure Fund returns and fund details are a) based on Series F units; b) net of fees; c) annualized if period is greater than one year; d) as at June 30, 2022; e) 2011 annual returns are from 09/01/11 to 12/31/11. The index is 100% MSCI World Core Infrastructure NR (CAD) and is computed by Ninepoint Partners LP based on publicly available index information. 1All Ninepoint Global Real Estate Fund returns and fund details are a) based on F units; b) net of fees; c) annualized if period is greater than one year; d) as at June 30, 2022; e) 2015 annual returns are from 08/04/15 to 12/31/15. The index is 100% MSCI World IMI Core Real Estate NR (CAD) and is computed by Ninepoint Partners LP based on publicly available index information.
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