U.S. Markets open in 6 mins

First Eagle Global Value Team 4th Quarter Commentary

- By Holly LaFon

Market Overview

In the fourth quarter of 2016, the MSCI World Index rose 1.85%, while in the United States the S&P 500 Index increased 3.82%. In Europe, the German DAX Index was up 2.52% and the French CAC 40 Index rose 2.86%. In Japan, the Nikkei 225 Index rose 1.01% over the period. Brent crude oil increased 13.93% to $54.96 a barrel and the price of gold fell 12.43% to $1,150.00 an ounce. The US dollar strengthened 13.18% against the yen and 6.14% against the euro.


During the quarter, we remained concerned about the level of global debt, which has continued to grow relative to GDP. Since the global financial crisis, the burden of debt has generally shifted from the household sector to the sovereign sector, as nations have run massive fiscal deficits to sustain economic demand. We believe that the aggregate level of debt in the world today, while not indi-cating that a crisis is inevitable, does constitute a vulnerability in the global economic system.

We are also concerned about persistent geopolitical challenges, including the growing impact of populism and nationalism on the world stage. Rather than being an isolated event, Donald Trump's victory in the US presidential election resonates with the swing to populism and nationalism that we've seen for some time globally--the same trend that manifested itself in the Brexit vote.

In China, an economic model based on urbanization and export-led growth has come under pressure from over-building, an accumulation of bad loans and a more fully valued currency. The path to a more service-sector-driven economy is fraught with complexity for China's banks and policymakers. At the same time, the Chinese are playing a more assertive role in contested coastal waters.

In the Middle East, many eyes are focused on ISIS, but there are other significant developments, as well. Iran, in the wake of its nuclear deal, is gaining access to more resources, and its economy is on an improving trend at the very moment that Saudi Arabia's is under pressure. Two competing visions of what the Muslim world should look like-- one on the rise, one in decline--are producing tensions and proxy battles throughout the Middle East.

In Europe, the forces of populism and nationalism are testing the architecture of the European Union (EU). The senior members of the European project face a series of challenges: resolving the EU's structure, negotiating a new status for the UK, reducing unem-ployment and recapitalizing Italian banks, to name a few.

In the United States, market expectations for future interest rates have gone through a minor regime shift after the election of Donald Trump as the next president. The incoming administration is promising meaningful fiscal stimulus through tax cuts and infrastructure spending at a time when the unemployment rate has fallen to below-average levels. This is stoking expectations of higher inflation and prompting a more hawkish tone from the Fed.

The potential showdown between a Fed that is aiming to tighten monetary policy and a Congress that wants to ease fiscal policy creates a more uncertain policy stage in a period when equity valuations are quite full.

Earlier in the year, the Bank of Japan targeted 10 -year government bond yields at 0%. Since then, rising bond yields in the United States have increased the interest-rate differential between the United States and Japan. The effect has been meaningful depreciation in the yen, which we expect will help the effort to reflate the Japanese economy. However, if and when inflation expectations begin to rise, the Japanese authorities will have to unwind their policy very judiciously to maintain control of these expectations.

In view of these issues, one might expect security prices to be low enough to offer investors the potential for compensatory returns, but these are not the conditions we observe. In the fixed income markets, many sovereign bonds offer the prospect of negative real returns, and in the equity markets, P/E ratios that are, in many cases, above historical averages seem to indicate below-average longer-term returns for many stocks. In other words, we may be living in a world where future investment returns are low and risks are potentially high.

Portfolio Review

First Eagle Global Fund

In the fourth quarter of 2016, the Global Fund Class A shares (w/out sales charge) returned -0.30%1 versus the MSCI World Index return of 1.86%. For 2016, the Global Fund Class A shares (w/out sales charge) returned 10.65%1 versus the MSCI World Index return of 7.51%.

Four of the five leading contributors in the quarter were financial firms based in the United States: Bank of New York Mellon, American Express, BB&T and Synchrony Financial. The rise in US interest-rate expectations helped to drive these gains. In a normal interest-rate environment, banks can earn two or three percent on their deposits, but with interest rates as close to zero as they have been, this has not been possible. The fiscal stimulus that President-elect Trump promised during the campaign may also provide a boost to bank lending, which has been sluggish.

Investors responded positively to the prospect that banks may have better results from both pillars of their business--deposits and loans.

Another leading contributor in the quarter was Deere & Company (DE), which operates in a marketplace that continues to be chal-lenging. With corn, wheat and soy prices all at below-average levels, farmers have been reluctant to commit themselves to large-scale equipment purchases. Because its business fundamentals were cyclically depressed, sentiment on Deere's stock was negative. However, in the fourth quarter, the company's earnings proved more resilient than the market had expected--not because of a material recovery in corn or wheat or soy prices, but because of Deere's discipline on cost. The company has been able to deploy robots in certain parts of its manufacturing process and to outsource other labor-intensive steps. At the same time, its business model, which now includes a larger component of services, has made Deere's profit margins less sensitive to declining demand.

Leading detractors in the quarter included gold bullion and shares of gold-miner Fresnillo PLC, which are components of our potential hedge in gold. Rising economic confidence and rising interest-rate expectations drove down the price of gold and gold-related stocks.

KDDI, a Japanese cellular company, also detracted. KDDI is largely a domestic Japanese business, and as the yen weakened, the stock's contribution to our portfolio (in dollar terms) declined.

SMC (SMC.AX), a Japanese company specializing in pneumatic controls, detracted, as well. Sentiment on the stock turned negative when several investors raised questions about the company's inventory and cash balances. Our close analysis of the company's fundamen-tals uncovered, in our view, no alarming changes at SMC.

KT&G, a Korean tobacco company, was another detractor in the fourth quarter.

First Eagle Overseas Fund

The Overseas Fund Class A Shares (w/out sales charge) returned -3.38%1 versus -0.71% for the MSCI EAFE Index. For 2016, the Overseas Fund Class A shares (w/out sales charge) returned 5.59%1 versus the MSCI EAFE Index return of 1.00%.

Leading contributors2 in the fourth quarter of 2016 included two Japanese insurers--Sompo Holdings and MS&AD Insurance Group Holdings. The share prices of both companies benefited from expectations that interest rates will rise. Investors also had a positive view of Sompo's discipline in allocating capital, as evidenced by its record of paying reasonable prices for acquisitions and distributing cash to shareholders.

Jumbo (JUMPO), a Greek toy retailer, was another contributor. The shares, which had fallen during Greece's debt crisis, advanced in the quarter, as the market took a more favorable view of the Greek economy and spreads on the country's sovereign debt declined.

Bouygues (EN.PA), a diversified French industrial group that is active in construction and telecommunications, also helped. The shares had weakened in April in the wake of a failed telecom merger, but sentiment improved more recently. In addition, because of its large construction and property businesses, Bouygues is perceived as a cyclical stock, and it benefited as investor preferences shifted from defensive names to more cyclical ones.

Mitsubishi Estate Co. (TSE:8802) was another contributor. The company has an exceptional real estate portfolio that includes about one-third of the Marunouchi district in Tokyo. Expectations of higher interest rates benefited Mitsubishi Estate and other Japanese real estate stocks.

Leading detractors in the quarter included gold bullion and shares of gold-miner Fresnillo PLC (FRES.L), which are components of our potential hedge in gold. Rising economic confidence and rising interest-rate expectations drove down the price of gold and gold-related stocks.

KDDI, a Japanese cellular company, also detracted. KDDI is largely a domestic Japanese business, and as the yen weakened, the stock's contribution to our portfolio (in dollar terms) declined.

Grupo Televisa (TV) detracted, as well. Donald Trump's critical remarks about Mexico in the course of the US election campaign caused the peso to weaken following his victory, and this weighed on the performance of Grupo Televisa shares. Nevertheless, the company's strong market position through 40 years of turbulent Mexican history, its robust balance sheet and our sense that a large discount on the peso had already been priced in made us comfortable about holding this stock.

SMC (SMC.AX), a Japanese company specializing in pneumatic controls, detracted, as well. Sentiment on the stock turned negative when several investors raised questions about the company's inventory and cash balances. Our close analysis of the company's fundamen-tals uncovered, in our view, no alarming changes at SMC.

First Eagle U.S. Value Fund

The U.S. Value Fund Class A Shares (w/out sales charge) returned 3.15%3 versus 3.82% for the S&P 500 Index. For 2016, the U.S. Value Fund Class A shares (w/out sales charge) returned 14.77%3 versus the S&P 500 Index return of 11.96%.

The top contributors to return during the quarter were Bank of New York Mellon Corporation, Synchrony Financial, BB&T Corporation, American Express Company and Alleghany Corporation.

The most significant detractors for the quarter were gold bullion, Agnico-Eagle Mines, Weyerhaeuser Company, Newcrest Mining Limited and Teradata Corporation.

We appreciate your confidence and thank you for your support.

Sincerely,

First Eagle Investment (Trades, Portfolio) Management, LLC

  1. Performance information is for Class A Shares without the effect of sales charges and assumes all distributions have been reinvested and if sales charge was included values would be lower. Past performance does not guarantee future results.
  2. This list excludes a security that was a "top contributor" during the period due to a corporate transaction involving the security's issuer.

  3. Performance information is for Class A Shares without the effect of sales charges and assumes all distributions have been reinvested and if sales charge was included values would be lower. Past performance does not guarantee future results.

This article first appeared on GuruFocus.