December 2022 Quarterly Report

Economic Outlook

We start 2023 at the crossroads of multiple potential economic outlooks. The question that plagued 2022 surrounding what will happen with rates has for the most part been answered. That being, they are going to be higher for the foreseeable future. The new question is, when will they settle?

Rates will potentially ease in early 2023 due to lowering energy costs. However, a difficult decision now arises. Are you willing to gamble on the potential easing of rate raises to encourage markets or are you banking on seeing stronger economic conditions before re-investing?

Most of the investment committee maintain their conservative view of, if in doubt, hold cash. However, the views of Height Capitals’ Investment committee remain somewhat divided in some areas. The attitude of renting the market rather than owning it also persists. ‘Renting’ means we are willing to hold certain markets but with the view of pivoting this position in the short term – either into or out of. The key to successful portfolio management is in the words of the great Kenny Rogers knowing “when to hold ‘em, [and] when to fold ‘em”.

In addition to the market analysis of the Investment Committee, Andrew Height has recently spent some time over in the US. During this time, he has undertaken his own boots on the ground evaluation of the current market, economic conditions, and general societal sentiment.

It has been about 10 years since his last visit and the contrast between conditions over this time was significant. The economy appears in better shape than it was previously, and confidence is higher than expected. The 10 years of stimulus seems to have done its job in buoying the US economy and it consequently felt like the public were better armed to absorb higher interest rates and increases in the cost of living. Both hard data and anecdotal evidence indicate discretionary spending remains high. It felt like all consumers have the ability to spend but the cost of purchasing similar baskets of goods has increased substantially.

The low US dollar over the past decade had allowed the country to emerge from their post GFC position which saw them on their knees. Government spending has allowed the US economy to strengthen particularly through their use of their significant market power, compounded by the relatively low dollar. This, however, has been at the cost of government debt. The federal fiscal position has ballooned to a position which has forced annual increases to the debt ceiling.

Andrew’s conclusion was that the economy was not cooling at the rate expected. John Venusti, whose roots reside in Boston, indicates sticky inflation was here to stay and as such, the ability to reduce inflation in the short term will be hard. Consumers continue to spend and low unemployment is likely to persevere especially in the lower income jobs. Service sectors continue to face challenges obtaining sufficient labour and this is expected to create a major issue moving forward as filling these roles will take time.

The second key issue Andrew identified was the increasing social divide. As usual, the cost-of-living pressures impact the low-income earners more than any other demographic. Medium and high-income earners will have capacity to get through the next 3 years of inflation. However, the low-income earners are expected to experience moderate to significant financial stress in the short term. Ongoing inflationary pressures are unlikely to create GFC like market conditions, but we will see a slowing of the wealth creation across the economy.

This will not be isolated to the US, and we expect a similar situation to be reflected in Australia. Over the past three decades the biggest contributor to wealth creation in Australia has been the property market. Lower rates and the additional gearing capacity this creates has led to a significant increase in the serviceability capacity of borrowers. We expect to see this pull back in the coming years as the market comes to terms with higher cost of living and the subsequent increase in the cost of debt. It continues to be a ‘wait and see’ situation for the Australian economy.

Based on our views of the market:

• The global economy is facing major inflationary pressures due to key factors, including the European energy crisis created through reduced supply from Russia, the increase in commodity prices, and labour costs which place pressure on all parts of the economy.
• Consequently, the global economy is expecting GDP to recede in the short term. While inflation may be flattening out, we still expect it to remain for the foreseeable future.
• The Australian market has been propped up by a booming commodity market. This has given the Australian governments (both federal and state) the ability to produce surplus budgets in the past year.
• The low unemployment rate will prompt the Reserve Bank to maintain their rate increase policy in early 2023. With high employment, we are likely to see the government take further steps to counteract inflation.
• The US market is stronger than expected. It is Height Capital’s view that the economy could see another 1.5% increase in rates. This is not factored into current markets. With strong inflation on core items including staples and food items, inflation is likely to stay above the governments’ benchmark for the foreseeable future.
• One area that Height Capital keenly watches is the personal saving ratio. In the US this has fallen to some of the lowest levels on record. It indicates the US economy is about to rollover and experience less growth over the coming years, as people no longer have the capacity to maintain their current lifestyle.
• Markets have been strong, and a return to growth focused investing has been a key driver of the recent bounce. The Australian market now only sits 1% below all-time highs. Height Capital have modelled out our expectation of markets moving into 2023 using earnings to indicate where we may be at the end of 2023.
• The US market is in a similar position, and we anticipate earnings may fall by up to 13%. If this eventuates, we expect to see the market correct by 10-15% in the coming months.
• European markets have performed well after a hard sell off throughout 2022. The end of year bounce driven by rolling over inflation has helped the market recover. We rate it at a fair value and will keep watching this market. However, expect this strength to come off in the short term.
• Emerging markets have experienced an interesting period. COVID lockdowns in China have created a long year for investors of this market. As we enter 2023, we see improving conditions in the emerging markets of Asia. This area remains attractive, but we remain cautious due to the geopolitical risk associated with the markets.

Asset Class Expected Returns (Long term):

 Asset Class Views:

Portfolio Performance

Our weighting to high quality equities has been good for the portfolio in the past 6 months. With investors returning to quality companies with strong and robust earnings, our portfolio has benefited. In addition, the use of active managers in the bond market has been beneficial as well. Their ability to move up and down the credit quality and spread has provided us with an outperformance.

The reopening of China has driven the latest bounce in Australia, especially in resources market. The Height Capital team are working on building out the next wave of thematic plays for the next decade of investment, which will become a key part of our investment strategy throughout 2023.

In the short term we are taking the current higher prices to realise investment opportunities and increase our cash. This will allow us to be ready to invest when the opportunity presents.

Balanced Portfolio

*Morningstar Australia Balanced Target Allocation NR AUD

The portfolio has outperformed on a 1, 3 and 6 months over the benchmark. The ability to hold additional cash at the right times has allowed us to take advantage of lower shares prices of some of our core holdings.

Growth Portfolio

*Morningstar Australia Growth Target Allocation NR AUD

The portfolio has outperformed on a 1, 3, 6 months and since inception compared to the benchmark. The ability to hold additional cash at the right times has allowed us to take advantage of lower shares prices of some of our core holdings.

High Growth Portfolio

*Morningstar Australia Aggressive Target Allocation NR AUD

The High Growth Portfolio has slightly underperformed in the first few months of this financial year due to our high allocation to cash and fixed interest compared with the benchmark. This has allowed us to outperform the long term benchmark over the period.

Major Changes

Height Capital High Balanced Portfolio

The following changes were made to the portfolio over the past 3 months:

• Exit your holding of BetaShares Nasdaq 100 ETF – Currency Hedged (HNDQ): The Investment Committee recommended removing this ETF from the portfolio due to the current economic outlook in the US. With inflation still not under control at 7.11%, the US Federal Reserve may have to pull harder on the interest rate lever to curb consumerism, leading to a hard landing and a possible recession for the US economy. This effect will undoubtedly lead to lower valuations across the board for US stocks. BetaShares Nasdaq 100 ETF – Currency Hedged (HNDQ) is a passive investment strategy designed to track the performance of the NASDAQ-100 Currency Hedged AUD Index (‘the Underlying Index’) before fees and expenses. The Underlying Index is a modified market capitalisation weighted US equity index comprising of the 100 largest non-financial stocks exclusively listed on either the NASDAQ Global Select Market or NASDAQ Global Market. The current underlying Index’s top 5 holdings include Apple, Microsoft, Amazon, Tesla and Alphabet, Google’s parent company.

• Exit your holding of Transurban Group (TCL): The Investment committee believe that TCL will not be a strong performer over the near team, due to its capital commitments to projects throughout the coming years that we think will have limited potential for capital growth. TCL is a toll road owner and operator with major assets in Australia, the US and Canada. In normal market conditions, toll revenue tends to be very stable with TCL driving growth by expanding its road network, growing traffic volumes and efficient operating. TCL has a strong development pipeline to be completed over the next 5 years, and while these projects are likely to limit distributions over the construction period, they will solidify TCL’s position as a globally significant toll road operator and maintain the Group’s average concession tenure. TCL has sufficient liquidity to meet its short-term capital and debt refinancing requirements.

Height Capital Growth Portfolio

The following changes were made to the portfolio over the past 3 months:

• Exit your holding of BetaShares Nasdaq 100 ETF – Currency Hedged (HNDQ): The Investment Committee recommended removing this ETF from the portfolio due to the current economic outlook in the US. With inflation still not under control at 7.11%, the US Federal Reserve may have to pull harder on the interest rate lever to curb consumerism, leading to a hard landing and a possible recession for the US economy. This effect will undoubtedly lead to lower valuations across the board for US stocks. BetaShares Nasdaq 100 ETF – Currency Hedged (HNDQ) is a passive investment strategy designed to track the performance of the NASDAQ-100 Currency Hedged AUD Index (‘the Underlying Index’) before fees and expenses. The Underlying Index is a modified market capitalisation weighted US equity index comprising of the 100 largest non-financial stocks exclusively listed on either the NASDAQ Global Select Market or NASDAQ Global Market. The current underlying Index’s top 5 holdings include Apple, Microsoft, Amazon, Tesla and Alphabet, Googles parent company.

• Exit your holding of Transurban Group (TCL): The Investment committee believe that TCL will not be a strong performer over the near team, due to its capital commitments to projects throughout the coming years that we think will have limited potential for capital growth. TCL is a toll road owner and operator with major assets in Australia, the US and Canada. In normal market conditions, toll revenue tends to be very stable with TCL driving growth by expanding its road network, growing traffic volumes and efficient operating. TCL has a strong development pipeline to be completed over the next 5 years, and while these projects are likely to limit distributions over the construction period, they will solidify TCL’s position as a globally significant toll road operator and maintain the Group’s average concession tenure. TCL has sufficient liquidity to meet its short-term capital and debt refinancing requirements.

• Exit your holding of Norther Star Resources Ltd (NST): The Investment Committee recommended exiting the NST holding in this portfolio due to the volatility of the share price over the past few months. While other gold producers have seen an increase in share price as investors look to gold for a hedge against inflation, NST’s share price has looked to be decoupled from the gold price and prevailing economic conditions. Due to this volatility, the Investment Committee recommended an exit and parking the funds into cash as we await further Buy opportunities. NST owns gold producing assets in three regional divisions, Kalgoorlie & Yandal in W.A, and Pogo in Alaska, U.S.A. NST merged with Saracen Minerals, effective 12 Feb’21, to form Australia’s 2nd largest gold producer behind Newcrest Mining (NCM). Synergy benefits to the value of A$1.5bn to A$2.0bn pre-tax is estimated with combined forecast output of 1.6Moz in FY22, targeting 2.0Moz per annum by FY26. NST is adding to reserves to extend mine life from its large 56Moz resource base with an active ongoing drilling program. Ongoing drilling expenditure ($143m in FY21 and $140m est. for FY22) to convert resources to reserves is a necessary cost to extend group mine life, along with updated resources at the Kalgoorlie Super Pit. The Pogo and Super Pit acquisitions are viewed positively with scope to improve respective mine dynamics. Pogo is making good progress with improved head grade mined and increased output expected in 2H22. Balance sheet is strong, with net cash of $173m.

Height Capital High Growth Portfolio

The following changes were made to the portfolio over the past 3 months:

• Exit your holding of BetaShares Nasdaq 100 ETF – Currency Hedged (HNDQ): The Investment Committee recommended removing this ETF from the portfolio due to the current economic outlook in the US. With inflation still not under control at 7.11%, the US Federal Reserve may have to pull harder on the interest rate lever to curb consumerism, leading to a hard landing and a possible recession for the US economy. This effect will undoubtedly lead to lower valuations across the board for US stocks. BetaShares Nasdaq 100 ETF – Currency Hedged (HNDQ) is a passive investment strategy designed to track the performance of the NASDAQ-100 Currency Hedged AUD Index (‘the Underlying Index’) before fees and expenses. The Underlying Index is a modified market capitalisation weighted US equity index comprising of the 100 largest non-financial stocks exclusively listed on either the NASDAQ Global Select Market or NASDAQ Global Market. The current underlying Index’s top 5 holdings include Apple, Microsoft, Amazon, Tesla and Alphabet, Googles parent company.

• Exit your holding of Transurban Group (TCL): The Investment committee believe that TCL will not be a strong performer over the near team, due to its capital commitments to projects throughout the coming years that we think will have limited potential for capital growth. TCL is a toll road owner and operator with major assets in Australia, the US and Canada. In normal market conditions, toll revenue tends to be very stable with TCL driving growth by expanding its road network, growing traffic volumes and efficient operating. TCL has a strong development pipeline to be completed over the next 5 years, and while these projects are likely to limit distributions over the construction period, they will solidify TCL’s position as a globally significant toll road operator and maintain the Group’s average concession tenure. TCL has sufficient liquidity to meet its short-term capital and debt refinancing requirements.

• Exit your holding of Norther Star Resources Ltd (NST): The Investment Committee recommended exiting the NST holding in this portfolio due to the volatility of the share price over the past few months. While other gold producers have seen an increase in share price as investors look to gold for a hedge against inflation, NST’s share price has looked to be decoupled from the gold price and prevailing economic conditions. Due to this volatility, the Investment Committee recommended an exit and parking the funds into cash as we await further Buy opportunities. NST owns gold producing assets in three regional divisions, Kalgoorlie & Yandal in W.A, and Pogo in Alaska, U.S.A. NST merged with Saracen Minerals, effective 12 Feb’21, to form Australia’s 2nd largest gold producer behind Newcrest Mining (NCM). Synergy benefits to the value of A$1.5bn to A$2.0bn pre-tax is estimated with combined forecast output of 1.6Moz in FY22, targeting 2.0Moz per annum by FY26. NST is adding to reserves to extend mine life from its large 56Moz resource base with an active ongoing drilling program. Ongoing drilling expenditure ($143m in FY21 and $140m est. for FY22) to convert resources to reserves is a necessary cost to extend group mine life, along with updated resources at the Kalgoorlie Super Pit. The Pogo and Super Pit acquisitions are viewed positively with scope to improve respective mine dynamics. Pogo is making good progress with improved head grade mined and increased output expected in 2H22. Balance sheet is strong, with net cash of $173m.

Portfolio Outlook

Our key strategy points are:

• To look for mature businesses at reasonable valuations as we see inflation reduce around the globe.
• Height Capital adopts a sector specific strategy as we look to increase exposure to equity markets. The key is to target robust industries and companies with strong balance sheets.

To receive this detailed report on a quarterly basis or should you have any questions, please email info@heightcapital.com.au