Market Overview
In the second quarter of 2015, the S&P 500 index fell 1.9%. Crude oil rose 24.9% to $59.47 a barrel, and the price of gold fell 1.0% to $1,172 an ounce by quarter’s end. The U.S. dollar strengthened 2.0% against the Yen and weakened 3.7% against the Euro.
Longtime investors in our portfolios know that we have been concerned for years about the financial repression by central bankers as well as the long-term impact of artificially low interest rates. We have recently seen signs that others are beginning to focus on these matters.
In its annual report published last month, the Bank for International Settlements asked: “Is the Unthinkable Becoming Routine?”1 The report noted the extended period of low global interest rates and went so far as to say low interest rates beget low interest rates through the perpetuation of debt growth and competitive policy easing. A cyclical response by central banks to the world financial crisis of 2008 has devolved into a generational shift. Global debt-to-GDP is higher today than it was in 2007, as debt shifted from the household and corporate sectors to the sovereign sector.
The day of reckoning cannot be delayed indefinitely, as Greece painfully demonstrated at quarter’s end. The standoff in Greece is reminiscent of the emerging markets debt crisis in the mid-1990s. In both cases, sovereign governments got into trouble by borrowing in foreign currency, so that they had to pay their debts in a currency they could not print. The challenges facing Greece are the exact opposite of the fiscal dynamic in the United States or Japan, where there is the ability to control the monetary supply. Consider that Japan has yet to reach economic equilibrium some 25 years after their financial crisis with interest rates still at virtu-ally zero. One could be cynical and say that Greece’s outstanding sovereign debt is a fraction of Apple’s market capitalization, and so, why does the country’s fate matter beyond its borders? Greece may be the proverbial canary in the sovereign coal mine. The outcome of Greece’s debt crisis will have potential repercussions for how the markets price sovereign risk, the European financial architecture, the emergence of broader capital controls, and the shifting political equilibrium in a world with excessive sovereign debt.
We are also keeping a watchful eye on China, given the recent decline in equity prices there. The Chinese are in the midst of a complex adjustment period, following an investment boom of record proportions. Now the government is tasked with shifting focus from investment spending to consumption spending. The problem China faces is that it is hard to stimulate spending when the core economic growth engines—exports and property development—are starting to soften. As a result, we strongly suspect the Chinese government will take further steps to ease policy. China’s leaders have a lot of levers that they can pull. But the equilibrium there is getting more complicated to maintain, and bears watching. While Greece may be a small economy, China is the economic equiva-lent of the proverbial elephant in the room. Its softening is already manifesting itself in pronounced weakness in global commodity prices and an evolving geopolitical dynamic in which there is a rapprochement between China and Russia whilst the relationship between China and the United States becomes more thorny.
As far as the health of the stock market overall, prices feel high to us. While price-earnings ratios are only slightly elevated, margins are quite high. By some measures we are approaching 1999 peaks in price-to-sale ratios—which could be a bad omen for equities.
As always, we never attempt to predict the overall direction of the markets, beyond highlighting where we see excesses and vulner-abilities. We continue to search for idiosyncratic opportunities in businesses that remain resilient in the face of cyclical disruption.
Portfolio Review
On the surface, there was no common theme to our investments last quarter. Our opportunity set was fairly diverse reflecting primarily bottom up opportunities whereby long-term resilience became undervalued at the individual company level due to weak stock price performance in response to short-term fundamental disappointment. Our patience and company by company implementation of investments enabled us to avail ourselves of these opportunities despite a rich market overall.
The five leading contributors to performance in the second quarter were Microsoft (MSFT, Financial), Comcast (CMCSA, Financial), Bank of New York Mellon (BK, Financial), Altera (ALTR, Financial) and Deere & Company (DE, Financial). The five largest detractors over the quarter were Teradata, Omnicom, Oracle, 3M and Berkshire Hathaway.
For the six-months ended June 30, 2015, the largest contributors to performance were Orbital ATK, Anthem, Altera, Martin Mari-etta Materials and Comcast. The biggest detractors to performance were National Oilwell Varco, Intel, Oracle, American Express and Teradata.
We appreciate your confidence and thank you for your support.
Sincerely,
First Eagle Investment (Trades, Portfolio) Management, LLC
The performance data quoted herein represents past performance and does not guarantee future results. Market volatility can dramatically impact the fund’s short-term performance. Current performance may be lower or higher than figures shown. The investment return and princi-pal 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 is 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 U.S. Value Fund 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.
Investment in gold and gold related investments present certain risks, and returns on gold related investments have traditionally been more volatile than investments in broader equity or debt markets.
The principal risk of investing in value stocks is that the price of the security may not approach its anticipated value or may decline in value. All investments involve the risk of loss.
The holdings mentioned herein represent the following percentage of the total net assets of the First Eagle U.S. Value Fund as of June 30, 2015: Microsoft 3.68%, Comcast 3.63%, Bank of New York Mellon 2.93%, Altera 0.63%, Deere & Company 0.94%, Teradata 1.60%, Omnicom 2.44%, Oracle 3.81%, 3M 2.29%, Berkshire Hathaway 1.98%, Orbital ATK 0.88%, Anthem 0.80%, Martin Marietta Materials 0.78%, National Oilwell Varco 2.40%, Intel 2.26%, American Express 2.46%, Altera 0.63%, Comcast 3.63% and Teradata 1.60%. The portfolio is actively managed and holdings can change at any time. Current and future portfolio holdings are subject to risk.
The commentary represents the opinion of the Global Value Team Portfolio Managers as of June 30, 2015 and is subject to change based on market and other condi-tions. The opinions expressed are not necessarily those of the entire firm. These materials are provided for informational purpose only. These opinions are not in-tended 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 views expressed herein may change at any time subsequent to the date of issue hereof. 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.
Standard & Poor’s 500 Index is a widely recognized unmanaged index including a representative sample of 500 leading companies in leading sectors of the U.S. economy. Although the Standard & Poor’s Index focuses on the large-cap segment of the market, with approximately 80% coverage of U.S. equities, it is also consid-ered a proxy for the total market. The Standard & Poor’s 500 Index includes dividends reinvested and is not available for purchase.
Investors should consider investment objectives, risks, charges and expenses carefully before investing. The prospectus and summary prospectus contain this and other information about the Funds and may be obtained by contacting your financial adviser, visiting our website at www.feim.com or calling us at 800.334.2143. Please read our prospectus carefully before investing. Investments are not FDIC insured or bank guaranteed, and may lose value.
1. www.bis.org
