First Eagle Global Value Team 2nd Quarter Team Commentary
Despite a downturn in May, the second quarter as a whole was a positive one for investment markets: global equities generally rose, credit spreads remained tight and implied equity volatility (as measured by the CBOE Volatility Index) was well below average. Interest rates remained extremely low both in the United States and abroad--particularly in Europe, where some $13 trillion of bonds are trading at negative yields.1 In addition to equities and bonds, currencies also experienced unusually subdued levels of volatility.
Over the course of the quarter, macroeconomic developments exerted a powerful pull on the markets. In April, better-than-expected economic data and accommodative central banks allayed concerns about global growth and propelled a rebound in risk assets. In May escalation of the US/China trade dispute darkened the outlook for global growth, sending stock markets lower and prompting rallies in perceived "safe haven" assets such as Treasuries and the Japanese yen. In June, more explicitly dovish comments from the Federal Reserve assuaged investors' concerns and sent markets higher.
On a number of occasions during the quarter, investors responded positively to news stories that, in our view, were not as favorable as they seemed. The most recent example was an apparent truce in the US/China trade dispute that was announced in late June. Though the market met this news with enthusiasm, major trade issues between the US and China-- including the need for agreement on a venue for managing intellectual-property disputes--remain unresolved; with a final agreement likely still some ways off, an escalation of tensions remains possible.
Late in the quarter, superficially good news also appeared in Europe, where there was heavy buying of sovereign debt on hopes that the European Central Bank (ECB) would continue its very accommodative monetary policy. But here, too, the outlook was not as sanguine as it appeared. The ECB has committed itself to using both conventional and unconven-tional policy tools to maintain an accommodative environment for banks and to help restore growth and inflation to target levels. However, with interest rates already below zero and asset purchases at the limits of the ECB's own rules framework, the ECB may not have enough firepower left to make a meaningful impact. Further, the transmission mechanism of ECB monetary policy has not functioned well, as the current long period of negative rates and central bank asset purchases has translated into neither inflation nor economic growth.
At quarter's end investors appeared to be complacent despite mounting signs that the current economic expansion, now the longest in US history,2 had reached a late phase. One such sign was an inverted Treasury yield curve; this phenomenon--in which the interest rate paid on long-term debt falls below that paid on short-term debt--has preceded all seven recessions since the 1960s. Whether or not the inverted yield curve remains an infallible predictor of upcoming recessions, the shape of the curve suggests that fixed income investors have low expectations for future economic growth.
Declining corporate profit margins were another sign that the economic expansion may have reached a late phase. Low unem-ployment and expanding capacity have put profit margins under pressure, and earnings expectations in both the MSCI World and the S&P 500 indexes came down significantly from the start of the year. Disappointing profits may cause companies to hold back on capital investment and hiring, which in turn may dampen investor enthusiasm for risk assets. Furthermore, given the high levels of sovereign debt around the world, governments may have limited ability to provide additional fiscal stimulus in support of business profitability.
In the late phase of an economic cycle, questions about liquidity typically come to the fore, and we saw several examples of this in recent months. In China, a small regional bank triggered a minor panic when it was unable to roll over certain liabilities. In the United States, mutual fund companies are adapting to the SEC's new liquidity requirements. In Europe, several investment funds suffered waves of redemptions because of the questionable liquidity of their holdings. We believe that many investors are underestimating liquidity risk in the investment markets--espe-cially in the credit and bank-debt markets.
One typical late-cycle signal is conspicuously absent in this period: a spike in inflation. Inflation has historically surfaced at the end of the economic cycle, and since WW II nearly all US recessions have been preceded by a run-up in inflation.3 While inflation expectations are currently low in the US, the EU and Japan, this may not be as reassuring as it sounds. Japan, for example, has experienced a number of downturns since 1989 that were not preceded by increasing inflationary pressure.
Portfolio Review
The Global Fund delivered a positive return in the second quarter but underperformed the MSCI World Index. The First Eagle Global Fund Class A shares (without sales charge)* returned 3.63% versus the 4.00% return of the MSCI World Index. North America, developed Europe and Japan led the way, but all regions contributed. On a sector basis, materials, financials, communications services, industrials and consumer discretionary were the standouts, and energy was the only significant detractor.
Leading contributors to the Fund's performance in the second quarter included gold bullion, KDDI Corporation, Danone S.A., Oracle Corporation and Flowserve Corporation.
Gold bullion contributed strongly both because its price rallied and because it was a large position in the portfolio. In this period, the price of gold responded to four factors in partic-ular: dovish comments from the Federal Reserve, geopolitical developments (including tanker explosions in the Persian Gulf), political unrest (such as tensions between Italy and Brussels over Italy's fiscal plan) and escalation of the trade dispute between the United States and China. We hold gold for its potential to enhance the resilience of the portfolio and to help avoid perma-nent impairment of capital. We do not speculate on its price.
Shares of Japanese telecom company KDDI (OTCPK:KDDIF) have fluctuated in recent quarters as investors have continued to digest the impact of the decision by Japan's Ministry of Internal Affairs and Communications to create another competitor in the country's mobile phone market. Investors have reacted quickly and severely to news about changes in KDDI's market share, and in the second quarter the news was not bad. Given the regulatory climate in Japan, we think the entry of another company will be orderly, for the most part, and we do not anticipate a price war.
Danone, a food and beverage company based in France, reported positive earnings. It also continued to retire debt that it incurred to acquire WhiteWave Foods, an American producer of plant-based foods and beverages.
Oracle, a US-based producer of enterprise data software, advanced after reporting strong operating reslts.
Flowserve--a manufacturer of industrial pumps, valves and seals--reported strong orders and improved operating perfor-mance. Overall, the company is seeing a broad-based recovery in its energy-related end markets.
The leading detractors in the second quarter were British American Tobacco p.l.c., Teradata Corporation, Bank of New York Mellon Corporation, 3M Company and Philip Morris International, Inc.
Shares of British American Tobacco and Phillip Morris Inter-national slipped in the second quarter after rising strongly in the first. Although tobacco consumption has been decliningworldwide, these companies have proven resilient as pricing improvements and cost discipline have outpaced volume declines. We believe that investor concerns about increased regulation of the industry and the threat of disruption from newer forms of nicotine consumption (e.g., vaping, heat not burn, snus) are well discounted in the valuation of these securities.
Teradata (NYSE:TDC) is an American provider of database software and analytics. Its shares fell sharply in the second quarter because investors were disappointed with its first quarter results. The entrance of new competitors also hurt the stock, though in contrast to some of these newcomers, Teradata has scalable products that work as advertised.
Shares in Bank of New York Mellon declined as falling interest rates put several of its businesses, including money market funds, under pressure. In our view, this is a contained issue at an otherwise very solid institution.
3M (NYSE:MMM), headquartered in Minnesota, is a conglomerate with indus-trial, worker safety, healthcare and consumer components. Its shares fell in April after it reduced its earnings guidance for the year--something it has done more than once in recent quar-ters. Investors expect 3M to be a steady and reliable performer and seem to overlook the fact that some of its business lines are economically sensitive. 3M's recent acquisition of a wound-care company got mixed reviews on Wall Street, but we have a posi-tive view of this transaction.
Overseas Fund
The First Eagle Overseas Fund Class A shares (without sales charge)* returned 4.10%, outperforming the MSCI EAFE Index which returned 3.68%. Developed Europe, Japan and North America made the largest contributions and emerging markets detracted slightly. On a sector basis, materials, industrials, consumer discretionary, financials and healthcare stood out, while real estate and information technology detracted.
Leading contributors to the Fund's performance in the second quarter included gold bullion, KDDI Corporation, Danone S.A., Kia Motors Corporation and Nestle S.A. The leading detractors in the second quarter were British American Tobacco p.l.c., Cielo, Lloyds Banking Group plc, Great Eagle Holdings Limited and CK Asset Holdings Limited.
U.S. Value Fund
The First Eagle U.S. Value Fund Class A shares (without sales charge)* returned 3.32% versus the 4.30% return of the S&P 500 Index. Sectors contributing positively to quarterly performance included information precious metals, financials and industrials with energy, consumer staples and utilities detracting.
The top contributors were Gold bullion, Flowserve Corpora-tion, Alleghany Corporation, W.R. Berkley Corporation and Oracle Corporation. Detractors included Teradata Corporation, 3M Company, National Oilwell Varco, Inc., Bank of New York Mellon Corporation, and Schlumberger NV.
We appreciate your confidence and thank you for your support. First Eagle Investment (Trades, Portfolio) Management, LLC
The performance data quoted herein represent past performance and do not guarantee future results. Market volatility can dramatically impact a Fund's short-term performance. Current performance may be lower or higher than figures shown. The investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Past performance data through the most recent month-end are available at www.feim.com or by calling 800.334.2143. The average annual returns for Class A Shares "with sales
charge" of First Eagle Global, Overseas and U.S. Value Funds give effect to the deduction of the maximum sales charge of 5.00%.
The annual expense ratio is based on expenses incurred by the Fund, as stated in the most recent prospectus.
These are the actual Fund operating expenses prior to the application of fee waivers and/or expense reimbursements.
The Adviser has contractually agreed to waive its management fee at an annual rate in the amount of 0.05% of the average daily value of the Fund's net assets for the period through February 29, 2020. This waiver has the effect of reducing the management fee shown in the table for the term of the waiver from 0.75% to 0.70%.
S&P 500 Index is a widely recognized unmanaged index including a representative sample of 500 leading companies in leading sectors of the US economy and is not available for purchase.
The commentary represents the opinion of the Global Value Team portfolio managers as of June 30, 2019, and is subject to change based on market and other conditions. The opinions expressed are not necessarily those of the entire firm. These materials are provided for informational purposes only. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice. Any statistics contained herein have been obtained from sources believed to be reliable, but the accuracy of this information cannot be guaranteed. The information provided is not to be construed as a recommendation or an offer to buy or sell or the solicitation of an offer to buy or sell any fund or security.
This article first appeared on GuruFocus.
