Financial markets closed 2022 with corrections (S&P 500 -18.5%, MSCI Europe -11.9%, IBEX -5.56%). Inflation and statements on interest rates from both the Federal Reserve and the ECB served as justification among investors for profit-taking in the wake of the generous rebounds of the last two months.
In the US, economic growth is proving stronger than anticipated and, doubtless, of better quality. Third-quarter GDP figures were revised upward, to +3.2%, on higher spending and non-residential investment, while Q4 2022 estimates improved. Retail sales also delivered an upside surprise, growing 7.6% during the holiday season. Inflation fared better than expected and the Federal Reserve cut its rate hike to 50 basis points (relative to previous increases of 75 bps), though it remained hawkish about further hikes in 2023, until still-high inflation is contained.
In Europe, economic growth is outpacing analysts’ forecasts and fiscal policy remains in expansionary territory. With regard to monetary policy, the ECB raised interest rates 50 basis points, to 2.5%, the highest level in 14 years, and announced that rates will continue to climb 50 bps with each meeting until inflation is under control. The central bank also announced that it would begin to run down its debt from March 2023.
The Spanish economy, however, continues to show signs of strength, following the upward revision of H1 data. With anti-crisis plans and EU funds accelerating Spain’s economy, GDP will grow by more than 5% in 2022, exceeding market expectations. In 2023, Spain will once again be one of the OECD’s fastest growing economies. Inflation eased one point in December, to close 2022 at 5.8%. Household spending remains positive, and the labour market closed the year with a very healthy balance sheet.
In 2022, we saw a major disconnect between company share prices and fundamentals. This was evident in our Spanish equity fund, EDM Spanish Equity, because although fund-company profits continue to show strong resilience, the majority of prices have fallen. We remain confident that the key driver of share prices over the long term is profit growth and, as such, we believe there is a clear opportunity to invest in quality companies, such as those that comprise the EDM Spanish Equity portfolio.
A good example of this is Inditex, whose results for the first nine months of the year exceeded market consensus estimates and surpassed those of its competitors, though its performance in 2022 was mediocre (-11.8%). Inditex demonstrated the resilience of its business model in a complex market context with strong organic growth, despite the closure of stores in Russia and Ukraine, the ability to raise prices by 5% on average without affecting sales, and improved operating margins. Sales grew 19%, net income rose 24%, and the company anticipates a good start to Q4 with double-digit sales growth. At current prices, with net cash on the balance sheet of nearly EUR 10 billion, it offers a dividend yield of 4.8%. We maintain that its fundamentals will once again be key to its profitability on the market and, therefore, it holds the top position in the portfolio at the start of 2023.
The leading contributors to the portfolio in 2022 were Repsol, Logista, Tubacex, and Vidrala, while the main detractors were Fluidra, Rovi, and CAF, the latter being top-quality companies and industry leaders with elevated growth prospects.
The five main positions in the portfolio at the start of 2023 are Inditex, Grupo Catalana Occidente, Gestamp, Repsol, and Logista. All are top-quality companies, again, priced unjustifiably low. Hence, the upside potential we see in the long term.
The fund embarks on 2023 with a very attractive selection of securities in terms of quality and valuation. It trades at an unjustifiable 2023 P/E ratio of just 9.6x with an average ROE of 16%. Based on current prices and our profit growth estimates for the portfolio as a whole (+10.5% annually), we expect the fund could double its net worth in five years. Therefore, we firmly believe that the current valuation of our EDM Spanish Equity portfolio offers an historic opportunity in terms of quality and valuation.
Ricardo Vidal,
Chief Investment Officer
