Dear Clients,

As the new year begins, we would like to provide you with a comprehensive update on your portfolios. It is important for us to discuss factors that have contributed to both strong investment performance in past years and the setback we experienced in 2022. As well, we would like to review our investment strategy and explain our plan of action to take advantage of opportunities we see in today’s market.

 

A Look Back

We often describe equity investing as a journey of “two steps forward and one step back.” Volatility is a normal part of the investment experience, though in recent years, this has certainly been taken to trying extremes in capital markets and in our portfolios.

 

Looking back, we see clearly how much of this volatility has been the result of pandemic-related distortions of various forms. When lockdowns first took hold around the world in 2020, human activity became synchronized on a global scale at an unprecedented basis. Large swaths of the physical retail and service sectors were forced to close; and commerce, education, entertainment, and social interactions had to shift online, practically overnight. Initially, most forms of manufacturing and production also came to a halt. Governments and central banks, fearful of economic collapse and financial duress for those affected by business closures, were quick to offer fiscal support and monetary stimulus through the issuance of stimulus cheques and the lowering of interest rates.

This resulted in many unexpected and unintended consequences:

 

Heightened Savings

For many people, the pandemic was a time of heightened savings. They were able to maintain their income levels by continuing to work in-person or online, or by receiving government support. Yet, spending levels generally declined because many areas of expenditure, notably travel and entertainment, were restricted.

 

Spending Distortions

Spending also became highly synchronized. Remote work and school required mass upgrades in personal computing technology and changes to living and working arrangements in the home. The latter, along with low interest rates, drove up spending in residential real estate and related areas. In general, spending on goods and technology rose sharply in the early stages of the pandemic, then pulled back later when the service sector reopened, shifting spending to other areas such as travel and entertainment.

 

Supply Chain Constraints

Lockdowns did not only affect consumption patterns, but they also added stress and pressure points to the global supply chain for a wide range of products. This resulted in heightened manufacturing and freight costs, and made it increasingly difficult for companies to accurately match production deliveries with demand.

 

Inflation

Synchronized spending coupled with supply chain constraints resulted in inflationary spikes first in the goods sector and residential real estate, then in the service sector as it reopened. High savings also contributed to attrition from the labour pool, resulting in a very tight labour market just as employment picked up with the full re-opening of the economy. Labour market tightness has, in turn, contributed meaningfully to inflation over the past year. The pandemic also initially suppressed residential rents only to result in steep adjustments to market rates over the past year, adding further pressure to inflation. Russia’s invasion of Ukraine was particularly untimely for inflation as it caused shocks in energy and food prices.

 

Rising Interest Rates

Central banks were initially slow to react to rising inflationary pressures, likely because prior to the pandemic, inflation was stable and low for a long time. In past notes, we have discussed structural factors that have contributed to this, namely aging demographics, low population growth in the developed world and technology-driven productivity improvements. However, this position changed due to concerns that inflation could be more entrenched than expected. As central banks eventually took to combatting inflation with monetary tightening, short-term interest rates rose sharply, resulting in meaningful valuation compression across most sectors of capital markets.

 

Our Investment Approach

Over the years, our investment approach has been carefully honed to incorporate learnings about the most important drivers of investment success in our evolving world. We have paid great attention to secular and structural shifts in consumer and corporate behavior given technological advancement, progress in consumer education, perceptions and attitudes, and development of societies in different parts of the world. We are also mindful that over the long term, the most significant driver of investment gains is sustainable profit growth, made possible by the most powerful and defensible business models and led by the most capable and forward-thinking management teams. Whereas some investors differentiate between “growth investing” and “value investing”, we see the two concepts as intertwined. A company that seems cheap on a conventional basis can, in fact, be expensive if its business success is short-lived or comes at a high cost. Conversely, it can be justifiable to pay a premium for a company whose long-term outlook is very strong due to its unique and highly profitable business structure and market positioning.

Undoubtedly, it is disconcerting to see portfolio declines as we did in 2022. In carefully assessing our investment decisions, we are most willing to learn from mistakes. However, we should note that the pandemic distortions discussed above threw “curve balls” that are apparent only in hindsight. Even so, we remain confident that our strategy of focusing on the highest quality companies in secularly growing industries will win out over the longer term.

 

The Way Forward

In times of challenge, opportunities always present themselves. We feel strongly that this is the case now. The herd approach in markets now centres on recessionary fears and other near-term concerns such as inflation. However, no economic state is permanent and there are inevitably self-correcting mechanisms in economies and capital markets, especially in the developed world. As such, we see evidence that various inflationary pressures, which have been the underlying cause of market weakness, are already in retreat. Thus, we view current market weakness as an opportunity to build positions around our strongest convictions, especially where they are currently out of favour or under-appreciated, and thus significantly undervalued.

 

In Closing

We would like to close by wishing you and your families the very best for 2023. If there is anything you would like to discuss with us, please do not hesitate to reach out.

 

 

Warm regards,

Woon Ai on behalf of Woon Ai Tsang Wealth Management Group