Market Overview
In the second quarter of 2017, the MSCI World Index rose 4.03%, while in the United States the S&P 500 Index increased 3.09%. In Europe, the German DAX Index was up 0.10% and the French CAC 40 Index fell -0.04%. In Japan, the Nikkei 225 Index rose 5.95% over the period. Brent crude oil fell −9.29% to $47.92 a barrel, and the price of gold fell -0.62% to $1,241.55 an ounce. The US dollar strengthened 0.83% against the yen and weakened -6.23% against the euro.1
As these numbers suggest, investor confidence remains elevated in most major world markets. Corporate spreads are tight, volatility is low, P/E ratios are high and asset prices are generally full relative to long-term history. This is not surprising, given the state of the world’s leading economic zones. The United States has below-average unemployment, a Fed that appears to be slowly normalizing policy and corporate profits that are expected to hit record highs. China, which eased fiscal and monetary conditions in response to pressures in 2015 and 2016, has seen a return to decent economic growth. Europe, too, has experienced cyclical improvement, with unemployment falling from high levels to modestly lower ones. And in the wake of the French elections, the markets have generally been constructive on Emmanuel Macron’s centrist agenda and the prospect of labor-market reform.
As we have said in the past, our outlook is less rosy than the prevailing market view. Looking out over the medium-term, we continue to have concerns. Household plus corporate plus sovereign debt relative to GDP remains higher than it was 2007.2 In the intermediate term, this high level of global debt will need to be addressed.
The second issue is China. Despite the recent relief there, conditions are likely to turn more challenging, in our opinion. China has seen a very rapid build-up in debt relative to GDP, and the government may need to use its balance sheet in future years to help the economy adjust. At some point, that could change people’s perception of sovereign credit risk in China.
The third risk is geopolitical. One has only to read the newspaper to know that we are at a sensitive moment in time, with North Korea testing long-range missiles, tensions rising between China and Vietnam in the South China Sea and fighting continuing in Syria. Wherever we look in the world, geopolitics are complicated.
We would describe this environment as one with above -average risk and below-average rewards. Passive investing may make sense when asset markets are inexpensive and offer attractive real returns, but that is not the case right now. In our view, this is an impor-tant time for an active, benchmark-agnostic, risk-aware strategy like ours that focuses on owning stocks with a margin of safety.3
Portfolio Review
Global Fund
In a pattern that has become familiar in strong market environments, the Global Fund delivered solid absolute returns in the second quarter of 2017 but underperformed the broader market. The First Eagle Global Fund Class A (without sales charge)* returned 1.54% versus the MSCI World Index return of 4.03%. This pattern reflects our belief that when stock valuations are relatively full, it is important for us to have some potential ballast (cash, cash equivalents, gold) in the portfolio. This is not a market-timing call; it reflects our strongly held belief that when expectations are high, a margin of safety is harder to come by. In the second quarter, we modestly increased the size of the Fund’s gold position in the belief that gold, which, historically, has appreciated in value, is a more effective form of long-term potential ballast than cash.
In the second quarter, the Fund’s absolute returns were positive in developed Europe, Japan, North America and emerging markets, but negative in developed Asia ex-Japan. In sector terms, financials, information technology and consumer staples were the largest contributors, and energy, materials and utilities were the leading detractors.
Among individual stocks, the top five contributors for the quarter were Oracle, Nestle, Deere & Company, Danone and American Express Company.
Oracle (ORCL, Financial) continued to demonstrate progress in transitioning its business from a front- end sales model to a cloud-based subscrip-tion model. Some investors had questioned whether midsize and smaller businesses would adopt the new model, but in the second quarter, these customers appeared to do so. The trend had a positive impact on Oracle’s share price.
Nestle (NSRGY, Financial), another contributor, responded to the demands of an activist investor by introducing more shareholder-friendly policies, including a share buyback program that has helped its stock price.
The top five detractors in the quarter were National Oilwell Varco, Schlumberger NV, Fresnillo, Barrick Gold Corporation and TechnipFMC.
National Oilwell Varco, Schlumberger and TechnipFMC all provide equipment and/or services to oil and gas exploration and production companies. Their share prices were affected by the decline in the price of oil.
Overseas Fund
The First Eagle Overseas Fund Class A shares (without sales charge)* returned 2.69% versus the MSCI EAFE Index return of 6.12%.
Leading contributors in the second quarter included Nestle, Danone, Haw Par Corporation Limited, KT&G Corporation and Keyence Corporation.
Nestle responded to the demands of an activist investor by introducing more shareholder-friendly policies, including a share buyback program that has helped its stock price.
We thought Danone (XPAR:DN, Financial) had paid a high multiple to acquire WhiteWave, which makes almond milk and other organic products, but it was able to offset some of the acquisition cost by divesting Stonyfield Farms at a similar multiple. Competition in the US yogurt market between Danone and Greek-style products seems to have abated, and Danone’s market share has stabilized.
KT&G (XKRX:033780, Financial), the Korean tobacco company, also contributed while allaying some investors’ concerns about its pricing. An excise tax accounts for the major share of cigarette prices in Korea, and KT&G believed that, despite an increase in the tax rate, it could raise the price of cigarettes without losing a sizable number of customers. Thus far, the company’s results have confirmed that its thinking was correct, and the stock advanced.
The top five detractors were Cenovus Energy, TechnipFMC, Fanuc Corporation, Liberty Global PLC and Grupo Televisa.
U.S. Value Fund
The First Eagle US Value Fund Class A Shares (without sales charge)* returned 0.69% versus the S&P 500 Index return of 3.09%.
Leading contributors were Oracle, Deere & Company, Xilinx, Bank of New York Mellon and Microsoft.
Leading detractors were National Oilwell Varco, Schlumberger NV, Synchrony Financial, TechnipFMC and ConocoPhillips.
We appreciate your confidence and thank you for your support.
First Eagle Investment (Trades, Portfolio) Management, LLC
