Water Fund Review February 2024

Febru­ary’s market trends

At the start of the month, the market dynamics were influenced by a hawkish stance from major central banks, inclu­ding the Federal Reserve, the European Central Bank, and the Bank of England, all signaling a reluc­tance to reduce interest rates immedia­tely. Despite this, a robust labor market and steady economic growth supported positive market senti­ment. Positive momentum started to be felt as earnings, especi­ally those of the “Magni­fi­cent 7,” exceeded expec­ta­tions by an average of 7% for the fourth quarter, surpas­sing long-term averages.

However, caution prevailed with warning signs such as relatively weak first-quarter guidance and indica­tions that profit margins were reaching a plateau. Infla­tion modera­tion in both Europe and the United States increased pressure on central banks to consider rate cuts. Meanwhile, Japan’s market experi­enced a sharp rise, with the Nikkei 225 surpas­sing its 1989 all-time high, marking one of the longest recovery periods in history.

Emerging markets faced challenges, with China being a notable excep­tion, rallying by 8% due to a govern­ment buying program and new regula­tions on short selling. On the other hand, political unrest impacted Mexico, while weak economic news affected Brazil, making them notable laggards in the global economic landscape during the month.

The Tareno Global Water Solutions Fund posted a perfor­mance of 7.02% (W‑Euro Tranche).

Our month in water – the Matrix

In the first The Matrix film, the lead character Neo is offered a choice by Morpheus: take the red pill to uncover the harsh truth behind the Matrix, or the blue pill to continue living in its fabri­cated reality.

Looking at the major contri­bu­tors to perfor­mance during the month, you could actually image yourself in a diffe­rent reality: Emcor, a player in piping, plumbing and the construc­tion of waste­water facili­ties +38%, China Water Affairs, a Chinese water utility, +35%, Ebara, a pump supplier from Japan +32%, Advanced Drainage Systems, a US supplier of storm­water drainage solutions +26%. Those perfor­mances came on the back of solid results, but the extent of the reaction to the positive surprises is remar­kable. The red pill anyone?

While we are enjoying the positive senti­ment in the markets, we are closely monito­ring the funda­men­tals and remain vigilant.

Funda­men­tals remain a mixed bag

The top three water sector macro data points grabbing our atten­tion this month include (1) municipal bond issuance bouncing back strongly from 2023 declines, (2) an inten­si­fying sell-off in ag commo­di­ties, and (3) capacity utilization hitting a multi-year low, which is bearish for industrial channel demand.

1. S. municipal bond issuance has seen dramatic fluctua­tions, with a signi­fi­cant rebound recently, surpas­sing $300 billion in trailing twelve-month issuance as of January 2024. The return of strong credit market access suggests munici­pa­li­ties might continue to prefer it over federal funds, that are still slow to flow.
2. Corn prices have sharply declined, falling below $4 per bushel for the first time since 2020. This ongoing decline, which started in May 2022, is affec­ting farm profi­ta­bi­lity and capital expen­diture, notably highlighted by a signi­fi­cant drop in irriga­tion sales reported by Valmont and Lindsay Corp.
3. S. industrial capacity utilization has reached a 28-month low, indica­ting a poten­tial slowdown in broad capital expen­diture cycles across the economy. Despite promi­sing trends in 2022, the current dip to 78.5% utilization suggests tepid near-term growth for industries, even with several long-term growth drivers.

Play defense!

We took some profits where we felt it might be appro­priate after the strong run they had in February. We trimmed positions in Emcor, Advanced Drainage Systesms and Ecolab. We used the proceeds to increase positions in compa­nies where we feel they are left behind despite solid results. Franklin Electric, Kemira and ZurnElkay Water. The time seems about right to slowly get back into the utili­ties. They under­per­formed as interest rates stayed elevated and cycli­cals were favored. This might not go on for ever and so we have again built a position in Essen­tial Utili­ties. The company is managing the supply and treat­ment of potable water, mostly in Pennsyl­vania. The shares haven’t traded this cheap in over 12 years and the dividend yield of 3.5% offers protec­tion.

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