Fidelity Australian High Conviction Fund

Over the June quarter, the Australian market traded largely sideways, in quite a narrow range and ended up the quarter slightly down. But within that, we saw quite a wide dispersion in performance between the sectors.

The best performing sectors were tech, healthcare and financials, whereas the worst sectors were energy and materials. But what we witnessed in the sector was a significant change in market sentiment.

If we think about the previous 12 to 18 months when a company would report an earnings miss, it was severely punished, down ten, 20%, in the day. But in the following days and weeks, it quickly recovered most or all of those losses. But in the quarter just gone, we saw a big change where companies reporting earnings misses were still being severely punished, but they weren't recovering quickly like we saw in the previous periods, they were staying down.

The consumer sector was particularly hard hit. There was some names down between 27 to 60% in a single day, with the likes of City Chic, Kogan, and Cettire. And what's driven this change in sentiment? I think it's largely the path of interest rates, which we called out last quarter as one of the key drivers of the market outlook.

And if you think about Australia, over the quarter, expectations for rate cuts went from two rate cuts by the end of the year, down to a 50% probability that there will be a rate hike this year. The key change, in this outlook was the May CPI print, where it showed that Australia was the only G10 country to show an increase in inflation, over the course of the year, with the trimmed mean inflation rising from 3.8 to 4.4%. That was well ahead of the market expectations and the RBA's own forecasts. So net higher interest rates mean lower valuations. But also, lower tolerance for earnings misses and a lack of earnings visibility.

In the last quarter, the Fund narrowly underperformed the market after a strong outperformance in the previous quarter. The key contributors to the performance were Aristocrat, who reported very strong, growth in their land-based slot machines in their key US market. They also talked about plans to divest their casual gaming business and also set some, relatively strong growth targets for their AI gaming business, which we actually think a conservative. So, they've painted a pretty strong medium-term growth profile.

Goodman was again another key contributor in the quarter. They increased their earnings guidance for FY24 for the second time. They're now expecting 13% earnings growth this year, which is up from 9% originally and then 11%.

And Polynovo was also another key contributor. They're continuing to print record monthly sales with the April period growing at a rate of 69% and they’re executing really well in the rollout of their burns treatment product.

On the other side of the coin the detractors were James Hardie, who issued lower than expected guidance for their FY25 year with the repair and remodel sector in the US still in the process of bottoming out. But offsetting this slightly was their investor day, where they set some long-term growth targets, which, are quite aggressive but also achievable we think.

Another one was Lifestyle Communities, which is a similar story in that the Victorian property market to which they're heavily exposed, is still in the process of bottoming out. There's a bit of excess supply in that market, given some changes that the government has put through inland tax rates there as well.

And finally, the underweight in banks is also a detractor during the quarter.

So, over the next quarter the key things we're looking at is again the path of interest rates and inflation. That's going to be a key driver for markets going forward. In Australia, my view is that the RBA is a very reluctant hiker. And if you look at the May figures released, there was a lot of noise in that data. So, headline inflation increased to 4% from 3.6% in the previous month.

But if we were to simply take out the travel and accommodation component, which is a very volatile item, we would have actually seen a ten basis point decline in headline inflation month on month. So, I think the RBA needs to see more than one month of data to recommence that rate hiking cycle. But what is clear now is we're in a stronger higher for longer period for interest rates in Australia.

The other thing that is top of mind is elections. In 2024, half of the entire world's population will see an election and surprises are becoming the norm. And of course, the US election is gaining steam.

And finally, the August reporting season is rapidly approaching. So, it's a pretty opportune time to look through the portfolio, think about where, if there are any earnings risks in the portfolio. We think again the focus is going to be on the consumer sector, but we're also looking to see some green shoots in the industrial, cyclical sectors where they've been in a down cycle for a number of years. And now things are starting to look like they're bottoming out.