Market outlook - Are we there yet?

The Munro Global Growth Fund has run with lower net exposure for much of 2022. The Fund has averaged 60% net exposure to equity markets since mid-January, however during the third quarter, we decided to take this lower to net 40% exposure to equity markets. This was done mainly via increasing our short exposure and various hedging tools.

While we had initially looked to get more constructive markets in July on the back of peaking long term interest rates, events did not pan out as we had hoped, and we reversed course through August and September. This proved to be the right decision and pleasingly, thanks to gains on short selling, hedging and currencies the Fund was up roughly 3.0% for the quarter and up 1.3% for September.

We have flagged for some time now the three things we are looking for to help identify the end of this bear market - below we update our current thoughts and detail why we have become more defensive markets.

Long term interest rates to peak

It has been our view that bond yields can only go up so much as there is simply too much debt in the world for long-term interest rates to get much higher than 3%. Initially, during July, there were signs that this was correct with US 10 year treasuries dropping from3.5% to 2.5% on slowing economic data. This proved short lived. Persistently high inflation data, increasingly hawkish rhetoric from Fed president Jerome Powell and three 75bps rate hikes have seen long term interest rates back up to touch 4% in September. This was the main reason why we reversed course with our net exposure as the higher rates lead to lower valuation multiples for all assets, with equities being no exception. While interest rates might have indeed peaked now at 4%, the higher rates for longer will also likely lead to amore protracted economic slowdown.

Earnings estimates to come down

Higher interest rates have caused havoc to valuation multiples throughout 2022, however we have only just started to see the economic damage that higher rates will do. Earnings estimates have only come off marginally for 2022 and analysts still expect 8% earnings growth in 2023for the S&P 500. This seems highly unlikely. A US 30-year mortgage has just hit 7%, having started the year at 3%. Even if the Fed stopped hiking interest rates tomorrow, it will be very difficult to avert a recession in 2023. Interest rates have simply moved too far too fast, if the Fed hikes further to kill inflation, then this will simply make the slowdown worse. The next few months is likely to see a significant and necessary reset of earnings expectations for 2023.

Lower earnings estimates will eventually lay the foundation from which the market can sustainably recover. Pleasingly, this is where the Fund is benefiting from short positions that are now starting to downgrade earnings because of the damage the Fed is causing in reducing inflation.

‍Time

The average bear market lasts just over 300 days and falls37% and if history is any guide, it pays to be patient in this environment. We continue to be wary of further exogenous shocks that could be precipitated by the higher interest rate environment. Obvious candidates include leveraged property players and leveraged countries. The UK’s recent mini budget has seen an unprecedented sell off in UK bonds and points to the government being unlikely to be able to fund their deficits. This is a warning shot to governments allover the world and suggests an era of fiscal austerity could be required exactly when most economies are going to require the opposite. Elsewhere the Russia / Ukraine and China are a source of much uncertainty and could provide further negative or positive shocks to markets should these issues worsen or be resolved. We continue to use put options that are designed to help manage volatility caused by these types of events.

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 The sun will shine again.

Longer term the sun will shine again, it always does. Astime passes, the Fed will regain control of inflation, interest rates willpeak, and the economy will bottom. Investors will eventually start looking overthe valley of uncertainty and toward what normalised earnings look like forstocks and take a longer-term view. The average bull market lasts 64 months,and you do not need to pick the bottom to enjoy the good times still when theyreturn.

Across all our portfolios, we own large capitalisation stockswith fortress balance sheets. Longer term, we know that these companies arepositioned to benefit from some of the most significant structural changeso ccurring in the world and hence remain confident that these companies can growearnings through the current uncertainties. We remain excited about theopportunities presenting themselves out of this current bear market and aresimply attempting to remain, prudent, disciplined and patient in what is adifficult time for markets

Disclaimer The material contained in this publication has been furnished for general information purposes only as is not investment advice of any nature. There can be no guarantee that any projection, forecast or opinion in these materials will be realised. The views expressed in this document may change at any time subsequent to the date of issue. Past performance is not a reliable indicator of future performance. This information has been prepared without taking account of the objectives, financial situation or needs of individuals. No representation or warranty is made concerning the accuracy of any data contained in this document. No permission is granted for republishing. Written3^rd October 2022.

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