The new year certainly started out down a very different path, with the global equity market falling sharply. The biggest talking point is clearly the Russia-Ukraine conflict, which has fuelled the inflation debate, slowed the path of global growth and rekindled geopolitical risks. The greatest impact has been on commodity prices, and looking into the detail reveals more of a story. Energy has been the standout sector with a 31% total return. Russia supplies 11% of global oil production and 17% of global gas (40% of European gas).
Early in the quarter, expensive technology stocks sold off, as these long-duration assets are more vulnerable to rising interest rates, but the late rally in markets pushed many valuations back up again. By quarter end, the materials and utilities sectors moved into positive returns, but every other sector finished down, with double digit falls in information technology, consumer discretionary and communication services. Value stocks outperformed growth stocks by a wide margin, especially those that that benefit from rising commodity prices and those that benefit from rising interest rates.
Central bankers have shifted their language on inflation and ditched the term ‘transitory’ as it was causing confusion. More importantly, they have started to take decisive action, by raising interest rates and unwinding the extraordinary levels of quantitative easing that have supported asset prices. News on COVID-19 and the omicron variant has faded into the background, with the positive stories of reopening and a ‘new normal’ approach to living with the virus, offset by the negative impact of ongoing disruption to global supply chains, especially in China with their zero tolerance approach causing major shutdowns. This continues to add to inflationary pressures.
The Sun Life MFS Global Value Fund F lagged the MSCI World Index for the first quarter. The strategy was strongly ahead of the index early in the period as high growth stocks sold off sharply, notably technology, where the portfolio is underweight. However, relative performance tailed off later in the quarter as commodity stocks (underweight) surged post the Russian invasion of Ukraine, and technology stocks rallied again.
The key detractors were stock selection in materials, consumer staples and industrials. Within materials, holdings in paint companies PPG Industries, Akzo Nobel and Axalta Coating underperformed due to raw material cost pressures. All are raising prices and confident of offsetting the impact over time, but there is always a lag effect. High levels of industry consolidation and historic pricing power suggests they will be successful. Within consumer staples, Henkel was weak for similar reasons. The Fund’s industrial holdings in Masco, Stanley Black & Decker, Ingersoll Rand and Johnson Controls were a drag on relative performance as shares were weak reflecting inflationary pressures, housing market exposure and general cyclicality as growth rates weakened. Energy was a small negative factor overall. Strong performance from holdings in ConocoPhillips, Hess and ENI failed to compensate for the underweight to the sector, given the strong rally.
Stock selection in communication services and healthcare, together with the underweight position in information technology contributed to performance. Within communication services, not owing high profile stocks, such as Meta Platforms (Facebook) and Netflix helped as both stocks fell sharply after disappointing on growth. The Fund’s holding in KDDI, the Japanese telecom provider, was also a positive factor. Strong performance in healthcare was led by holdings in Bayer, Johnson & Johnson and Medtronic, which all performed well. Within information technology, avoiding stocks like Shopify and PayPal and the underweight to Microsoft were the key reasons for good stock selection.