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Whitney George on 3Q13 - The Market May Be Signaling a Return to a More Typical Recovery: Royce Funds Commentary
Posted by: Holly LaFon (IP Logged)
Date: October 7, 2013 01:33PM
Despite the Fed’s indecision about whether or not to taper, we see evidence that business activity is normalizing and the global economy is getting healthier.
Co-CIO, Managing Director, and Portfolio Manager Whitney George talks about how economically sensitive sectors have begun to benefit from rising rates in the small-cap rally, how recent news coming out of China has affected certain portfolio investments, where he is currently seeing long-term opportunities, and stocks in which he has high confidence.
What was most significant about the market’s strong performance in the third quarter?The most significant event actually started in May, before the beginning of the third quarter but continuing through it—and that was the normalizing of interest rates. Rates began to rise in May after having bottomed out in the summer of 2012.
However, the rate of increase really took hold late in the second quarter and early in the third quarter. While much of the attention has been on the Fed’s indecision about whether or not to taper, it seems the market has been indicating that the global economy has been getting healthier and doesn’t require subsidized rates as more normalized business activity becomes more and more common.
We saw much better performance from economically sensitive sectors in the third quarter, such as Technology and, even more notably, Industrials, Energy, and Materials, where we’ve focused a lot of our efforts over the last few years. There was also a noticeable pick-up in M&A activity across the market cap spectrum, which had been pretty subdued over the last couple of years.
We also saw many companies taking advantage of low rates to borrow cash and use the proceeds to buy back their own shares at what managements have regarded as very attractive prices.
As a whole, we’ve gradually seen markets and businesses behaving more along the lines of what we would expect in the early stages of an economic recovery.
How has the better news recently coming out of China affected your portfolio investments?China’s slowdown was probably beneficial to U.S. consumers because it took inflationary pressure off key raw materials, so a pick-up for China can be something of a mixed blessing for us.
However, it’s definitely been helping certain holdings of ours in the Industrials, Materials, and Energy sectors. For the last five years, China has been the leading market, or among the leading markets, for a number of industrial and other commodities.
I think many people have been missing the fact that China’s economy has been operating on a far larger base than it was 10 or even five years ago. The important point is that China’s slowing economy—growing at around 5%—represents far more aggregate demand and consumption than when its economy was growing at double digits five or 10 years ago.
So the focus on growth rates has been a little misleading, I think, without being seen in the context of the sheer size of China’s overall market.
In which industries or sectors have you been seeing the most interesting long-term opportunities?Mostly in those I mentioned previously—Materials, Industrials, Technology, and Energy. An increase in global demand led to a pick-up in a couple of key industries in the Materials sector, in particular chemicals, which have been strong for a few years, and steel, which has been depressed until recently.
Globe Specialty Metals, which is a sizable holding in several portfolios, is a good example. Its price fell pretty steadily through mid-July, but has been climbing steadily since then. The company produces silicon metal and silicon-based specialty alloys that are critical ingredients in a number of industrial and consumer products. It’s still in the early stages of a recovery, but we continue to like its long-term prospects.
We also find the rebound for many Technology stocks to be very encouraging. Tech has been participating in the overall rally. Although returns haven’t been dramatic, they’ve been steady.
We also continue to see opportunities mostly in companies that produce hardware, such as semiconductor capital equipment businesses. There’s also been more interest in upgrading telecom networks, which is helping stocks in that space.
Finally, we’ve seen what we think are great opportunities in the Energy sector as capital is clearly moving into Canadian energy businesses with plans to export natural gas to Asia. We see a strong long-term arbitrage opportunity between the cost of producing gas in Canada, where it’s abundant and priced off local markets, and shipping it to Asia, where it’s priced off oil.
Canada seems to be rapidly realizing that this is a terrific business opportunity while the U.S. has been less decisive. This affects several energy services companies that we really like but whose stock performance has been dormant for the last couple of years—such as Trican Well Services, Calfrac Well Services, and Pason Systems.
Can you discuss a few other stocks in which you have high confidence right now?We feel really good about Nu Skin Enterprises, which was one of the top performers in a few portfolios year-to-date through the end of June and also enjoyed a really strong third quarter. The company makes personal care products and nutritional supplements and sells via a multi-level marketing structure.
We’ve owned shares for more than a decade and built our position through 2012 and into early 2013 when its shares were getting hammered. There was a lot of noise from the hedge fund world about the viability of multi-level marketing companies, particularly Herbalife.
Over the last several months the company’s decisively proved hedge fund managers and short sellers wrong by continuing to execute successfully around the globe at a level that exceeded even our optimistic expectations. We’ve enjoyed success with Nu Skin primarily by being patient, by paying attention to the fundamentals, and by sticking with our long-term outlook.
Myriad Genetics is another company we’ve owned for many years—we first bought shares in 1998. The company develops molecular diagnostic products that assess an individual’s risk of disease development. It’s struggled through most of this year primarily owing to a Supreme Court decision that challenged the patentability of human genes and led to the company losing some patents.
We see this as a problem the company can overcome. Unlike most of its competitors, Myriad has a proven track record in genomics, which we continue to see as a significant part of healthcare.
Thor Industries is an RV maker that had a lot of success in the first half that continued to do well in the third quarter. We first bought shares in 1988. We’ve always seen it as a well-managed business with terrific fundamentals.
Its recent success has been the result in part of how effectively it managed its way through the recession. Now financing for RVs is expanding while the company has a terrific, focused management and a commanding share of the market.
Important Disclosure Information
Whitney George is Co-Chief Investment Officer and a portfolio manager of Royce & Associates, LLC, investment adviser for The Royce Funds. He serves as portfolio manager for Royce Premier Fund (RPR), Royce Low-Priced Stock Fund (RLP), Royce Global Value Fund (RGV), Royce Focus Trust (FUND), and Royce SMid-Cap Value Fund (RSV). He serves as assistant portfolio manager for Royce Micro-Cap Fund (RMC), Royce Value Plus Fund (RVP), Royce Value Fund (RVV), Royce Capital Fund – Micro-Cap Portfolio (RCM), Royce Global Select Long/Short Fund (RGS), and Royce Focus Value Fund (RFV). The thoughts and opinions expressed in this interview are solely those of Mr. George and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.
This material is not authorized for distribution unless preceded or accompanied by a currentprospectus. Please read the prospectus carefully before investing or sending money.Investments in securities of micro-cap, small-cap, and/or mid-cap companies may involve considerably more risk than investments in securities of larger-cap companies. (See "Primary Risks for Fund Investors" in the respective prospectus.) Investments in foreign companies may be subject to different risks than investments in securities of U.S. companies, including adverse political, social, economic, or other developments that are unique to a particular country or region. (Please see "Investing in International Securities" in the prospectus.)
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