As earnings season has kicked into gear with companies around the world reporting their results for the third quarter of 2023, we have new and important information which can help guide our decision making as investors.  While it is still early in the earnings season, with most companies still yet to report over the coming weeks, we still have enough data to make some early conclusions which support the view we have taken throughout the year so far.

In some sectors we continue to see strength in demand levels and corporate results for businesses exposed to those trends.  Meanwhile other sectors continue to see weakness for varying reasons and those related businesses continue to report weaker results.

This has, in fact, been the story for the economy and stock market since last year. 

For example, we saw a major slowdown in 2022 in demand for electronic goods and the semiconductors which go into those products, causing a significant reduction in growth rate expectations for related companies in 2023.  If we look at the most recent data for this sector, nothing much has changed.  Demand remains weak in this sector as smartphone, PC, and traditional server demand remains lacklustre following record demand levels pulled forward during the pandemic.  This will reverse slowly and there is talk of a meaningful inflection next year, making investments in the sector attractive today, but nonetheless weakness remains. 

On the flipside, demand for cloud computing services, particularly in AI (artificial intelligence) has seen very strong growth this year, continuing the trend of strong growth in broader cloud IT services despite concerns around the macro economy.  This space, especially the leaders in it, continues to see strong demand. 

Even within consumer products there is a wide divergence.  In high end luxury, we have continued to see very strong demand growth among high income consumers in virtually every geography.  There is no ‘China slowdown’ or ‘weak US consumer’ when it comes to buying Birkin handbags or Ferraris.  Those consumers continue to spend and the related companies selling to those consumers are doing just fine.  Lower down the value chain, growth rates have slowed but for the leaders, whether in cosmetics or fashion, growth rates across most regions have remained solid.  It is the less well managed businesses in these sectors which have suffered the most in terms of corporate performance, and as such, stock price performance.  Owning the higher quality, better performing businesses in this sector has worked well.

Given the considerable divergences between businesses within sectors, as well as between sectors themselves, and the ongoing uncertainty in the macro economy, investors are right to find the current situation challenging.  How do you position yourself given the high levels of uncertainty and wide divergences between companies and sector performances?

Our view is that the combination of a deep focus on valuation with an active approach to investing to focus on those sectors where growth is likely to remain resilient, offers a considerable margin of safety for long-term investors.  Short-term gyrations in markets, uncertainties about the macro economy, even new geopolitical risks emerging in the Middle East, all can work against the patient investor to cloud judgement and trigger unnecessary selling or market action.  Remaining focussed on the fundamental value of the equities we own and having the discipline to buy when others are selling, is the path to success through bouts of market turbulence.

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