Author: Daniel Sullivan, Head of Global Natural Resources | Portfolio Manager

Bond demand on the slide as inflation expectations climb and the equity risk premium hits a multi-decade low, with the correlation between equities and bond yields turning more negative. The largest stocks continue to crowd out the market. Over in Japan the key equities index has finally returned to its pre-1990 peak. More listed equity is being bought back than issued as IPO activity remains stagnant. Finally we look at shifting volatility and benchmark returns for the March quarter.

Biggest monthly drop in Fund Manager Survey bond allocation since July 2003

Source: Bank of America Global Fund Manager Survey

Market implied US inflation over the next five years

Source: Bloomberg, @lisaabramowicz1

US equity risk premium at a 22 year low

Source: Bloomberg

Rolling 2-month correlation between US equities & 10-year bond yields

Source: Morgan Stanley Research via @Schuldensuehner

Market cap of the largest stock relative to the 75th percentile stock

Source: @LanceRoberts, RIAAdvisors.com

Small cap stocks <4% of US equity market

Source: KobeissiLetter (data from CRSP, The University of Chicago Booth School of Business, Jefferies)

Japan's Nikkei 225 finally recovers to its 1999 record

Source: Equitable Investors, Koyfin

Net share issuance by companies on MSCI All Country World Index, adjusted for price and currency changes ($US billion)

Source: Financial Times

Global IPOs by quarter

Source: WSJ, Dealogic

Changes in US bond volatility (MOVE, RHS) v US equity (VIX, LHS) & Aus equity (ASX 200 VIX, LHS)

Source: Iress, Equitable Investors

Volatility benchmarks v average since July 2021 and move last week

Source: Iress, Equitable Investors

March Quarter (3 months) performance of key benchmarks and our "FIT" universe of ASX micro-to-mid caps

Source: Iress, GuruFocus, Equitable Investors

April 2024 Edition

Property values continue to increase across the majority of the country, with CoreLogic's National Home Value Index recording a further 0.6% increase in March, on par with what was achieved in February, resulting in 14 months of continuous monthly growth. Perth continued to be the strongest performer, increasing by a mammoth 1.9% for the month, followed closely by Adelaide with 1.4% and Brisbane with 1.1%. Signs of cooling have begun in Canberra, Sydney and Hobart, with 0.4%, 0.3% and 0.2% growth respectively. Melbourne achieved parity for the month, whilst Darwin is the only capital to experience a loss, falling by 0.2%. This monthly data contributes to a 1.6% national increase for the quarter, with all capital cities experiencing some level of quarterly growth except for Melbourne, where a 0.2% reduction has occurred.

As we wait for the next RBA meeting, scheduled for the 7th of May, there are growing calls by economists for a rate reduction to occur, driven by the continued slowing of GDP growth and falling inflation. Whether or not a reduction is made in May, it appears all but certain that throughout 2024 there will be reductions, which will likely result in a further bump to property prices in the coming months.

Clearance Rates & Auctions week of 2^nd of April 2024

Property Values as at 31^st of March 2024

Median Dwelling Values as at 31^st of March 2024

Quick Insights

Steadfast Forecast

Oxford Economics Australia, a leading economic institute has forecasted median property to grow to almost $2 million in Sydney alone within the next 3 years.

"You have a fundamentally undersupplied market and with net overseas migration running at half a million people, a growing participation by foreign buyers, downsizers and cash buyers, demand has outweighed that drag that interest rates would typically have.", said Maree Kilroy, Oxford Economics senior economist.

Source: Australian Financial Review

Affordability is the Trend

The medium-high end of the Sydney housing market may have finally reached a peak that lower end buyers cannot afford as a flood of homebuyers move into previously affordable suburbs driving prices up.

The lower end market has grown 5 times as fast as the higher end in past 6 months, and is likely to continue as more people seek to delay the effect of the housing crisis in their lives.

Source: Australian Financial Review

Author: Filippo Sciacca, Director - Investor Relations, Asset Management and Compliance

Imagine a colossal gold mine, Australia's largest no less, where its scale and longevity could be confused for an iron ore mine in the Pilbara. Where massive trucks navigate the landscape with uncanny precision, devoid of almost all human drivers. This isn't science fiction; it's the reality at Boddington, a mine that has rewritten the rulebook on gold mining best practices in autonomous haulage and is paving the way for future rollouts across Newmont's portfolio.

Boddington's drive for efficiency, safety and sustainability and lessons for the future

I was fortunate enough to recently visit Newmont's Boddington Gold Mine (BGM), located some 120km south-east of Perth. For 16 years under Newmont's management, Boddington has been a consistent gold producer at scale, churning out copper-gold concentrate and gold bars. Newmont has mine life extension plans that could see the BGM operation extend to 2059. Currently, Newmont mines from the astutely named North and South pits, but by the end of the mine's life, the pit design would eventually merge into one, rivalling Kalgoorlie's world-renowned Super Pit.

Source: Tyndall AM, March 2024.

A Pioneering Journey: The rise of AHS at Boddington and the learnings

Boddington's Autonomous Haulage System (AHS) journey is a story pushing the boundaries of both productivity gains and ESG standards. With a fleet of 41 CAT 793F trucks, these behemoths are guided by the sophisticated CAT MineStar operating system. Launched in 2021, this system has propelled Boddington to the forefront of mining technology, making it the world's first open-pit gold mine to boast a fully autonomous haulage fleet. The US$150 million project to convert the legacy fleet was completed ahead of schedule and under budget, even amidst the disruptions of COVID-19.

The AHS roll out encountered several challenges during its commissioning phase including in-pit communications issues, severe weather and heavy rainfall, shovel reliability issues and issues managing in-pit bench hygiene. These obstacles provided valuable learning opportunities through commissioning. Key learnings from the roll out have been focused on optimising the mine plan design to best suit the operating conditions of the AHS fleet, such as straightening roads and removing intersections. AHS trucks abide by a set of strict rules that ensure a predictable and safe outcome. These rules include slowing down at intersections and around bends and when coming into proximity with light vehicles. Additionally, meticulous road maintenance and assessing ramp gradation became crucial for the improved operations.

It is believed that 95% of learnings from Boddington can be replicated across future AHS fleet roll outs at other assets (discussed later). Many of the learnings are also applicable to non-AHS fleet with the issues identified by AHS fleet communicated to Newmont's other open pit operations.

Justifying the investment: Outcomes witnessed to date and the benefit of a systematic approach

After 13 years of 100% Newmont ownership, it took the AHS fleet only 12 months to beat the tonne per kilometre of movement performance record by 10%. Under the company's roadmap (refer Figure 1), management believes there is another 10% of productivity upside available. These productivity improvements will be achieved via a combination of improved truck availability (reduced downtime) and increased tonnes per kilometre.

The benefits of AHS extend far beyond mere operational efficiency, with safety taking centre stage by removing human interactions with large and heavy machinery. Human error is significantly reduced as a result of autonomous trucks meticulously following designated paths and operating parameters. Critically, this translates to a dramatic decrease in the risk of fatalities and vehicle collisions.

Figure 1: Newmont's full potential productivity potential roadmap

Source: Boddington, March 2024.

The environmental benefits are undeniable. Reduced fuel consumption due to optimized operations translates to lower greenhouse gas emissions. Since the introduction of the AHS, the Boddington operation has achieved significant fuel efficiency, saving approximately 1.5 million litres per year. Additionally, less wear and tear on tyres and other consumables contribute to a more sustainable mining operation.

The financial and productivity improvements - alongside the improvements in safety - boil down to operating discipline. Human operators compensate when the mine plan or operating conditions are not optimal, making it very hard for managers to identify issues and correct appropriately. Autonomous trucks strictly adhere to all operating constraints, so when an issue is encountered, the system will alert operators in control and the truck will stop operating. This results in bottlenecks being identified and rectified more rapidly than when humans operate trucks.

For example, if the optimal path from the pit floor to the crusher is blocked due to poor bench hygiene, the human operator, depending on factors like KPIs and mine culture, could choose a longer route and leave the rectification of the optimal route outstanding. However, the autonomous truck fleet will flag this issue with control and the optional route will be restored, leading to savings on future diesel consumption and increasing productivity.

A future powered by AHS: Further opportunities within the Newmont portfolio

The potential applications of Boddington's AHS learnings are vast. The ability to remove workers from hazardous environments and improve production efficiency makes AHS a compelling proposition across some of Newmont's core assets. Underground mining operations at Cadia and Lihir are prime candidates for this technology. The Lihir ore body, for example, sits within an extinct volcano where ground temperatures can reach up to 80 degrees celsius. Regular geysers can erupt, making it too dangerous for humans to walk the pit floor, providing a significant opportunity for better remote operated technologies.

ESG benefits of AHS offers improved risk adjusted outcomes

AHS rollout is just one tool in the toolbox to realise latent operational value from a financial and ESG standpoint, while decreasing the risk of a material safety event occurring and offering improved risk adjusted returns. The benefits of deploying AHS are clear; it can reduce operating costs, reduce fleet maintenance and improve productivity alongside improving safety, all of which align with the ethos of responsible and sustainable mining practices. Other Tyndall portfolio companies are also championing autonomous solutions, including Rio Tinto and BHP. At Tyndall, we analyse these metrics in absolute, relative, and directional trend terms, with safety metrics critical factors in both our assessment of the investable landscape and portfolio construction process.

Author: Tom Hays, Research Analyst

In his annual letter to investors, released on 24 February 2024, Warren Buffett drew the public's attention to the increasing wildfire risk that electric utility investors in parts of the US are exposed to.

He confirmed this risk had negative ramifications on essential investment required to support utilities and communities alike. This messaging was further reinforced by the experience of Xcel Energy, who in early March confirmed that its assets in Texas were likely responsible for the ignition of the Smokehouse Creek wildfire.

Strong words from Buffet on an increasingly concerning utility risk

Buffett drew broader investor attention to an issue which is already well understood by US utility investors, attributing the poor performance of Berkshire Hathaway Energy (BHE) to increased wildfire risk - to "the regulatory climate in a few [US] states has raised the spectre of zero profitability or even bankruptcy (an actual outcome at California's largest utility and a current threat in Hawaii)".

This was in reference to BHE's utility company, PacifiCorp (referenced in the previous article listed above), which BHE believes is facing at least $8 billion in legal liability claims associated with fires it allegedly ignited in October 2020^[1]. The scale of such potential liabilities obviously raises the question of the financial viability of PacifiCorp.

To this Buffett stated, "At Berkshire, we have made a best estimate for the amount of losses that have occurred. These costs arose from forest fires, whose frequency and intensity have increased - and will likely continue to increase - if convective storms become more frequent".

Importantly, with regard to BHE's appetite in bailing out the company from financial distress Buffett stated, "Berkshire can sustain financial surprises but we will not knowingly throw good money after bad"^[2].

This should be a major concern for legislators and regulators in exposed states, as an electric utility in financial distress (potentially bankruptcy proceedings) will struggle to attract investment capital and service its customers. This is particularly important in the current environment, with massive capital investment required to support the energy transition and power demands of AI and data centres. Indeed, Buffet recognises the investment proposition on which utilities were historically based could be in question, "Now, the fixed-but-satisfactory return pact has been broken in a few states, and investors are becoming apprehensive that such ruptures may spread".

Xcel Energy the latest utility at risk

Shortly after the release of Buffett's investor letter, Xcel Energy confirmed that its assets are likely to have ignited the Smokehouse Creek wildfire in Texas. A lawsuit against the company has claimed that one of the company's utility poles near Stinnett, Texas, had been blown over by strong winds sparking the initial blaze.

The fire based in the largely rural Texas panhandle and parts of Oklahoma burnt around 1.2 million acres, destroyed 400-500 structures, and is associated with two casualties. Despite it being too early to understand the potential legal liabilities facing the company, Xcel Energy's share price fell 17% (representing a c.US$6 billion devaluation in market capitalisation) in the week after media reports implicated the company in the fire. This again reinforced the risk facing electric utility investors from the unintended ignition of wildfires.

The states, and therefore companies, physically exposed

One major problem in identifying wildfire risk is that the geographies exposed to wildfires are increasing over time as a result of global warming - which we touch on in our article,  Extreme weather risks and their impact on investors. Despite the increasing occurrence, the states that are currently most exposed to wildfires are depicted by UBS below, utilising data provided by FEMA on the National Risk Index. The map shows that the highest risk areas are in the western, central and southern parts of the US.

^{Source: California Board of Forestry and Fire Protection (CAL Fire)}

The map helps identify states that are most exposed to wildfires, and the utilities which have significant operations in those states (listed in the table below). This provides a first pass as to utilities in 4D's investment universe which have/could have risk from wildfires.

This a high-level geographic assessment only and captures many of the US utility operators. A deeper dive would see some with little real wildfire exposure at present as they operate in more urbanised areas with little vegetation to support the damaging fires - for example CenterPoint Energy Houston Electric (in the Texas section of the table above) have confirmed that their operations in downtown Houston is highly unlikely to be impacted.

Other considerations to wildfire liability exposure

Other major considerations as to electric utilities' exposure to wildfire liabilities include:

 1) how prepared electric utility companies are to mitigate physical wildfire risks;

2) what litigious environments exist in various states; and

3) are companies able to manage wildfire liabilities of various scale if incurred?

These are the areas that 4D undertakes significant due diligence in when considering a company for investment.

When researching a potential investment in a US electric utility that is in (or could develop into) a high wildfire risk geography, we spend significant time understanding the company's wildfire mitigation preparedness.

This incorporates getting a thorough understanding of wildfire mitigation plans in its totality, which incorporates vegetation management processes, situational awareness (video monitoring of the network, lineman visual inspections, and drone surveillance), investment in hardening the network from fire ignition, and established public safety power shutdown (PSPS) procedures as a last resort. Significant investment in the insulation of overhead wires, replacement of weak/old power poles and undergrounding of wires in particularly high-risk regions all 'harden' the grid from wildfires.

The particular litigious framework established in individual states identified in the table above vary considerably. Some key factors, which will influence the level of legal liability risk, include:

• Absolute cap on liabilities - some states have established legal liability caps on the absolute amount that an individual/company can be litigated for.
• Judge vs jury presided courts - jury courts are more likely to be influenced by their emotions (with wildfire damage being very emotional for communities) rather than by the strict interpretation of the law.
• Whether punitive damages can be applied in addition to actual (property) damages -punitive damages are often multiples larger than actual damages, which are usually massive for wildfires in their own right. The application of punitive damages is usually dependent upon the establishment of gross negligence on behalf of the company, which should have a high threshold of evidence, but this has been depleted in some examples. A jury court in Oregon ruled that BHE's PacifiCorp was grossly negligent in its operation of the network during the October 2020 fires in the state, based largely on the company not shutting power off in the lead up to the fires. This would have had far reaching operational ramifications that made the decision far from straight forward. The court's decision is being appealed. The level of wildfire preparedness (or robustness of wildfire mitigation plans) that a company can demonstrate will reduce the risk of being found (grossly) negligent by a court.
• Specific state-based legal concepts - some specific legal standards can be applied in individual states such as inverse condemnation in California (see The real risk of wildfires to US infrastructure investors for more information on this). 

The question of a company's ability to manage wildfire liabilities will be dependent upon its balance sheet capacity and liquidity, which are obviously influenced by its size. Smaller electric utilities, including smaller municipal owned utilities, will be less able to manage large legal liabilities and are more likely to be forced into financial distress and/or bankruptcy. Could this be a driver of M&A consolidation in some states?

A financially distressed company is unlikely to have the capacity and/or willingness to continue to invest much-needed capital in the networks (replacement, growth and hardening) which could hinder economic and social development in the exposed region.

We expect there will be growing questions around insurance for these events - what can be insured, what premiums will do as this risk intensifies, and when does insurance pay out? It could get harder for utilities to protect themselves from this risk.

4D's approach

Wildfire risk is becoming a bigger concern for market investors and is probably something that is still being understood. At 4D, we don't recommend avoiding these companies from investment altogether.

 We do, however, recommend thorough due diligence of the risk to a company before taking a position. As always, we balance quality, risk and return in making investment decisions. In some cases, that risk will be too great - as Buffett outlines, there is the potential for the adoption of risk that outweighs the potential regulatory return of a utility, which can end up in the loss of all equity value (as experienced by PG&E Corp). However, in others we see the moderated risk more than compensated by valuations, with network hardening against fires also a strong driver of earnings growth.

^{The content contained in this article represents the opinions of the authors. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely as an avenue for the authors to express their personal views on investing and for the entertainment of the reader.}

^{[1] Warren Buffett's western utility facing untold billions in wildfire damages after the latest bombshell jury verdict came down - The Associated Press; 7/3/2024}

^{[2] Charlie Munger - The Architect of Berkshire Hathway; Warren Buffett; 24/2/2024}

2023 global equity returns were dominated by an alphabet soup of megatrends. From (Chat)GPT shining the spotlight on the lifechanging potential of Generative Artificial Intelligence (GEN AI), to a broader adoption of Glucagon-Like Peptide -1 (GLP-1) diabetes drugs for weight loss and other obesity-related diseases.  These megatrends resulted in extraordinary share price movements across multiple sectors as investors crowded into the themes and quickly decided who the winners and losers may be.

As we head into the third month of 2024, we continue to see these megatrends dominate equity market returns. In contrast to 2023, there is a clear bifurcation between megatrend beneficiaries that can deliver revenue and earnings growth and those that can't.  This is not only evident within the Magnificent 7 ("Mag 7"), but also across other so-called GEN AI and GLP-1 winners and losers.

Alphinity continues to have selective exposure across both megatrends.  Within GEN AI, we have exposure to early AI winners, such as Nvidia and Microsoft. In addition, we continue to invest in opportunities across the broader AI ecosystem.  SK Hynix, ASML, Cadence and Accenture are examples of technology enablers and facilitators where AI is augmenting company performance. Importantly, we continue to look further afield across sectors to companies not only enabling AI but those that will also reap its benefits.

We also have a nuanced exposure to the GLP-1 megatrend where the initial market clamour to define "winners" and "losers" delivered some interesting opportunities. While market leader and key GLP-1 winner, Novo Nordisk, has seen strong share price gains, assisted robotic surgery company Intuitive Surgical was initially dropped into the loser bucket on account of minor exposure to gastric banding. The market has since recalibrated ISRG expectations, and the shares have more than recovered the initial knee jerk reaction.

A further broadening out of these megatrends should continue to create exciting new "show me" opportunities in 2024 and beyond.

GEN AI - Show me the earnings

GEN AI truly entered our lives in 2023.  OpenAI's humanlike generative AI Chatbot, ChatGPT kicked off a wave of excitement across consumers and companies.  What ensued was a whirlwind of AI investments and developments across multiple industries as companies explored different ways of delivering AI building blocks or integrating these technologies into their businesses.

During 2023, many companies in the AI ecosystem got swept up in the euphoria.  From the enablers and infrastructure providers on the front end (such as semiconductor makers and data centres) to those that design software and provide related services (including end-user applications and cloud computing), amongst others.  None more so than the Mag 7.

While 2023 saw the rising AI tide lift most Mag 7 boats, year-to-date there has been a large divergence in performance amongst the group, defined by those that can deliver earnings growth to justify high multiples and those who can't.  AI posterchild, Nvidia, has added another c60% YTD, to be up more than 440% since the start of 2023.  Importantly, during this time the Nvidia forward PE multiple has come down, from 44x to 32x. The stock has got cheaper as earnings have outstripped the remarkable share price growth. Other major enablers such as Amazon and Microsoft have continued to rally supported by strong results from increased AI demand also.

Meanwhile Tesla and Apple have been dethroned by GLP-1 winner Eli Lilly and AI winner ASML, who now occupy their top 7 spots in YTD contributors.  Both Tesla and Apple are facing a range of challenges, but also recently disappointed investors with the lack of progress with their AI related plans.

Bifurcation within the Mag 7 driven by strong earnings power or the lack thereof:  Nvidia derated despite 441% return over the 14 months

Source:  Bloomberg, 29 February 2024

While industry data suggest a rapid adoption of AI across industries, the enablers continue to lead the charge year-to-date.  Recent 4Q23 result releases and capex intentions underscore the longevity of investment intentions across enablers and adopters.  AI mentions were at all-time highs as AI diffusion becomes more commonplace and remains a top CIO priority.

While AI is emerging as one of the largest innovation cycles in decades, we are only in the early innings of its diffusion.  It will take time for AI to impact revenues and margins more meaningfully and more broadly.

Microsoft company quote 4Q23 results:  "We are also the leader in low-code/no-code development, helping everyone create apps, automate workflows, analyze data and now build custom copilots. More than 230,000 organizations have already used AI capabilities in Power Platform, up over 80% quarter over quarter."

Conclusion

In times when the stock market is infused with captivating megatrends, such as GEN AI and GLP-1, there is a tendency for investor expectations to overshoot. Resulting in share prices of perceived beneficiaries running on speculation and the fear-of-missing-out rather than fundamentals.  The intense market concentration and diverging price movements of the last 14 months is a good case in point.

Looking ahead, we expect to see a continuous evolvement and adoption of both GEN AI and GLP-1.  Assessing long term winners and losers along the way will be crucial and fluid.  At Alphinity, we will continue to deploy our agile, tested investment process to find "show me" megatrend earnings leaders in 2024 and beyond.