Another month, another Trump tariff
Another month, another Trump tariff, this time on the EU – and already paused until early July – and now struck down by the US Court of International Trade. Somewhat counterintuitively, Loftus Peak in May has been materially outperforming respective indices for the month – more on this below.
The bond market is not happy. From the beginning of April until the time of writing, the US ten-year bond yield jumped enormously from 3.99% to 4.59%, which of course means a decline in the value of all US treasuries. This is important of itself, and of course will mean a rise in interest rates of 60 basis points (4.59% -3.99%) for borrowers across the US – students with student loans, businesses large and small, homeowners and more.
Meanwhile, AI companies in which Loftus has invested, such as Nvidia, Broadcom and Taiwan Semiconductor Manufacturing, are surging, showing gains of over 15% in the month of May. At the time of writing, Nvidia reported that second quarter revenue expectations were appreciably higher than analyst estimates.
Bond market concerned about recession
What the bond market was saying during April and May is that the tariffs on China must be reduced. Even Trump seemed to have understood that a worsening bond market creates significant difficulties for US corporates including his billionaires support group, and paused the Chinese tariffs which were the cause of the harm.
So his decision to tariff the European Union at a rate of 50%, which appears to have been conceived and regretted in haste, is baffling. The bond market continues to be unimpressed generally with the state of US finances. It is reacting to the latest Moody’s downgrade, increasing US deficits, and a generally chaotic US President. Additionally, the higher interest rates are likely to slow the economy broadly, so that a second quarter of low or even negative GDP growth is possible. Economists are predicting economic growth of +1.5%, and this would be a happy outcome. But if the number is below zero, then this would be a second quarter of negative GDP growth, after the March number of -0.3%. The US would be in recession. No wonder the bond market sees few reasons for optimism.
Against this backdrop, and as disclosed in the April performance review, Loftus Peak produced a return of +1.6% net of fees, which was outperformance against a falling benchmark (the MSCI All Countries World Index, in A$) of +3.11% for April. It is doing well in May, but there are still a few days to run.
The strength of the equity market in May has been strange. The reality is that some level of higher tariffs will remain. Exactly what this means, and so how it must be accounted for, will likely cause businesses to be more cautious. This could mean anything from pausing capital expenditure plans to halting marketing campaigns and even stockpiling goods at pre-tariff prices.
Cyclical exposure cut
We have been aware of this possibility, naturally, since the beginning of the year, when the tariff talk began, and so in the portfolios we manage have cut exposure to cyclical companies such as Qualcomm and Onsemi in favour of disruptors with a longer duration, such as Nvidia and Broadcom, as the slide below shows. Additionally, there have been sufficient data points over the past few months for an increased weighting in favour of companies which have a high exposure to artificial intelligence.
Net portfolio change* from end of January to mid March
Source: Loftus Peak
Why cut cyclicals? Not because they are bad investments, but because the timing of any improvement is business for them is pushed out by higher rates and uncertainty.
Apple’s problems are significant
The company that was not long ago the largest in the world by market capitalisation has been relegated to third place, behind Microsoft and Nvidia (both core holdings). However, might there be even more of a slide ahead?
Apple may have lost the advantage of a tightly integrated supply chain in China following Trump’s trade war. Having begun the process of shifting much of US iPhone production from China to India, Trump has suggested he’s even unhappy with that – requiring Apple to bring iPhone manufacture back to the US. An additional imposition, that Apple not pass on the US$300 plus cost increase to customers while the company relocates its low paying jobs to the US, is both practically and financially nonsensical. Separately, the re-emergence of Huawei in the domestic Chinese smartphone market is also resulting in share loss in China.
Even looking past tariffs, Apple’s lucrative services business is coming under pressure. It is possible that the company loses the >US$20bn in revenue (pure profit) paid by Google as the defacto search engine in Apple’s Safari browser. Meanwhile, Apple recently lost an important decision in a long-running legal battle with the publisher of the game “Fortnite.” This could result in even further services revenue degradation, as App developers on iOS are now able to direct users outside of the App Store to transact (removing Apple’s ability to take its 15-30% revenue clip).
The realisation that Apple could leverage a services business on top of its hardware install base was the Loftus Peak thesis for investment in 2014. This thesis played out and the market re-reated the stock. Yet now as headwinds gather for that same business, the company still trades at a premium to the broader market.
Digital advertising blogger Eric Seufert put it well when he described Apple as being besieged on all fronts. We think so too, having exited the stock on valuation grounds almost two years ago.
Meanwhile, there is an intention to increase exposure to life sciences companies and also in China, but only where the investee companies fit the disruption mould.
For our investors the most prudent course of action is to stick with companies which have the strongest cashflows, the most revenue growth and the best operations teams. That is how the portfolios have delivered outperformance over time. If the approach is correct, then good performance should continue.
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