Market Commentary
With a new year upon us, we remain in uncharted equity and economic waters. In the US, the current bull run has been the longest on record, as has the ongoing economic expansion. With unprecedented levels of global monetary stimulus, however, questions remain as to how much of the equity market’s rally over the past 10-plus years should be ascribed to central bank liquidity.
Still, for most market participants and observers the 2020 macroeconomic outlook appears positive, buoyed by a number of factors. The Federal Reserve, for example, lowered rates three times in 2019 but more recently indicated that it did not intend to move rates up or down in 2020. Although profound strains between the United States and China will not easily be resolved, the signing of the first phase of a trade accord signaled a thaw in relations between the world’s two largest economies. A landslide victory by the Conservative party in the UK’s December general election reduced the likelihood of a disruptive hard Brexit. Finally, relative calm has been restored in the Middle East following a late-December/early January spike in tensions between Iran and the US that seemed to herald the start of a more dangerous phase in the region.
All of these factors ought to contribute to a favorable environ-ment, but we have always been wary of consensus views, and we know the market often prefers to climb a “wall of worry.” There-fore, rather than tilting the portfolio in a particular macroeco-nomic direction, we will continue to focus on choosing invest-ments we believe to have strong free cash flow from historically high-return businesses while remaining agnostic with respect to economic or political outcomes.
Portfolio Commentary
Fund of America delivered a positive return in the fourth quarter. Fund of America Class A shares (without sales charge)* returned 4.93%, underperforming the 9.07% increase of the S&P 500 Index.
As in the first three quarters of 2019, fourth quarter perfor-mance was primarily driven by stock-specific factors. The benefit of remaining committed and being patient with our positions was illustrated by the portfolio’s best performing stock for the quarter. This stock hit a 52-week low in December 2018, but in late November 2019, the company received an all-cash bid at more than four times its December 2018 price. Our thesis in this stock played out in 2019 as we expected, yet 12 months earlier the market ascribed little worth to what we viewed as a very valuable asset.
Our portfolio, which is composed of an idiosyncratic blend of stocks, continued to trade with a free-cash-flow valuation approximately 400 – 500 basis points higher than the risk-free rate (10-year Treasury yield). While we may be wary of an overly complacent market environment, we are guardedly optimistic about the portfolio.
Leading contributors to the Fund’s performance in the fourth quarter were Medicines Company, Wyndham Destinations, Inc., Wyndham Hotels & Resorts, Inc., Zillow Group, Inc. Class C and Innoviva, Inc.
Medicines Company (MDCO, Financial), a biopharmaceutical business focusing on cardiac health, announced that it will be acquired by Novartis for $9.7 billion (or $85 per share).
Wyndham Destinations (WYND, Financial) contributed positively in the quarter as the company continued to make strides toward executing on its long-term strategy of seeking to profitably grow its customer base and to generate strong free cash flow. Wyndham Destina-tions reported solid earnings growth in the third quarter.
Wyndham Hotels & Resorts (WH, Financial) reported solid earnings and the resolution of its dispute with its largest franchisee, Corepoint Lodging, Inc. The company continued to repurchase its own shares at what we considered a discount to their intrinsic value and to grow its room count internationally.
Zillow (ZG, Financial) reported better than expected earnings for the third quarter. The company continued to expand its new fast-paced home buying and selling operation (its “Homes” segment) while executing better on its legacy listings business. The addressable market for Zillow’s Homes segment is very large and, in our view, continues to represent significant potential upside for the stock.
Innoviva (INVA, Financial), which is active in the development, commercializa-tion and financial management of biopharmaceuticals, gained in the quarter as the activist investor that has taken over manage-ment of the company has slashed operating expenses and begun to grow the company’s free cash flow. We believe the royalty stream that Innoviva generates continues to be undervalued by the market.
Positions that detracted most from performance in the fourth quarter of 2019 were Ball Corporation, ServiceMaster Global Holdings, Inc., Perrigo Co. Plc, TherapeuticsMD, Inc. and Cree, Inc.
Ball Corporation (BLL, Financial), which produces metal cans for food and beverages and has a separate aerospace business, reduced its free-cash-flow guidance for the year due to higher capital expendi-tures and a voluntary pension contribution above its original plan.
ServiceMaster (SERV, Financial), the parent of Terminix pest control and other residential and commercial service businesses, reported earnings that were below expectations due to an issue in its termite-control business in Alabama.
Perrigo (PRGO, Financial), a manufacturer of over-the-counter pharmaceuticals that is registered in Ireland, detracted in the quarter despite solid third- quarter earnings as the company continued to dispute tax penalties that were imposed in 2018 and 2019. We believe the intrinsic value of the business is being impaired by this overhang and expect resolution of these issues to begin in 2020.
TherapeuticsMD (TXMD, Financial), a pharmaceutical company focusing on women’s health, detracted in the quarter as revenues grew more slowly than expected. The company continued to grow, however, and we believe the market undervalues the revenue potential of its assets.
Cree (CREE, Financial) reduced guidance for its LED component business and estimated more gradual near-term growth in adoption of its silicon carbide products for use in electric vehicles.
We thank you for your continued support,
Sincerely,
First Eagle Investment (Trades, Portfolio) Management, LLC
The commentary represents the opinion of the Fund of America team as of the date noted and is subject to change based on market and other conditions. The opinions expressed are not necessarily those of the 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, hold or sell or the solicitation of an offer to buy or sell any fund or security.
