The Magellan Financial Group Ltd (ASX: MFG) share price has spiked 8.69% to $13.63 per share in lunchtime trading on Wednesday.
While there has been no news released by the company today, many investors may still be digesting Magellan's annual market review, released yesterday.
Meantime, the broader market is also up today, with the benchmark S&P/ASX 200 Index (ASX: XJO) rising 1.72% so far.
What's news at Magellan?
Yesterday, Magellan released its Magellan InReview 2022, providing insights and commentary on the global investment landscape today.
Magellan Global portfolio managers Nikki Thomas and Arvid Streimann described why and how inflation, income inequality, geopolitics, and climate change will dominate global economies and markets in the next year.
They point out that the efforts underway to resolve these challenges will favour quality companies.
In terms of how to navigate today's "uncertain and unbalanced world to protect capital", the pair said they remained focused "on investing in only high-quality companies that can cope with the challenges the world faces".
They wrote:
We are seeking companies that we expect to be resilient during the tightening of financial conditions and those that can benefit from such conditions. This means companies that are protected from rising and high inflation or indeed can benefit from high prices.
In terms of the portfolio, a world of rising interest rates has prompted us to scale back our holdings of energy utilities that had risen on their bond-proxy allure when rates were low.
We avoid growth (but not cash-generating) companies that are susceptible as valuations are deflated by higher discount rates and we exited those similarly vulnerable due to low cash generation now.
Our concerns about China prompted us to exit Chinese-domiciled stocks.
We added banks that are likely to enjoy higher margins as interest rates return to more normal levels.
We have added high-quality defensive companies with pricing power and minimal commodity and labour-related cost pressures.
A pushback against inequality has driven many policy changes of late in countries from China to the US that act against investment returns.
The risk for equity investors is that any lowering of the corporate profit share of national income will weigh on overall equity returns. Rising social-licence risks contributed to our decision to reduce our holding in Meta Platforms Inc (NASDAQ: META).
The top five holdings in the Magellan Global Fund (ASX: MGOC) as of 30 June are Microsoft Corporation (NASDAQ: MSFT) 7.8%, Visa Inc (NYSE: V) 6%, Alphabet Inc (NASDAQ: GOOGL), (NASDAQ: GOOG) 5.6%, Mastercard Inc (NYSE: MA) 5.1%, and McDonald's Corp (NYSE: MCD) 4.5%.
Switching focus from rising rates to earnings resilience
Thomas and Streimann comment:
Assuming no more shocks, the dominant driver of equity market returns is likely shifting from interest rates to earnings; in particular, downgrades to earnings expectations. This is a natural sequence when higher rates slow economies.
As a result, the Magellan Global Fund is "holding a cash level moderately higher than usual".
They add:
We will seek to use this money to buy high-quality companies at great prices as we navigate the volatility induced by the uncertain backdrop.
We remain confident that the portfolio is positioned to benefit from longer-term investment thematics and secular growth tailwinds to above-GDP growth in many segments of industry.
These include digitalisation trends across our lives – in payments, in enterprise processes, in advertising, entertaining and retail spending – as well as the energy transition and electrification and rising usage of data analytics via increased computation speeds.
How are quality companies performing in the bear market?
The pair say earnings estimates for S&P 500 (INDEXSP: .INX) companies have shown resilience in 2022, especially due to the booming energy sector and commodity prices.
But they add:
European earnings could be susceptible to downgrades; Chinese earnings expectations have already been downgraded. We expect more downward pressure on earnings outlooks through the balance of this year as companies review guidance. Broad capitulation of negative earnings revisions is normally a prerequisite for a bottoming in equity markets.
As Streimann explains in the accompanying Q & A: "Quality companies tend to be defensive, which means they provide reliable earning streams. They have low leverage and high returns on capital."
He added:
Growth-focused quality companies tend to have profits further into the future than most other companies. That means their valuations are more sensitive to higher interest rates, which have gone up significantly this year. While we still consider these quality companies, this mechanical link between interest rate hikes and valuation has dragged down the overall quality index.
What else is happening at Magellan?
Yesterday, Magellan announced the official appointment to the board of its new CEO and managing director David George.
George is replacing Magellan co-founder Hamish Douglass, who will now work as a consultant to provide valuable investment insights, including geopolitical and macroeconomic views.
Douglass is expected to begin in his new role on 1 October after an extended period of personal leave.
