In the fourth quarter of 2019, the AMG Yacktman Focused Fund (Trades, Portfolio) (Class N) appreciated 6.9%, lagging the S&P 500® Index’s 9.1% rise and the Russell 1000® Value’s 7.4% increase. For the year, the Fund appreciated 19.1%, lagging the market’s 31.5% rise as measured by the S&P 500 Index. A significant part of that lag was a reversal of the strong outperformance our Fund delivered in the fourth quarter of 2018 when it declined just -3.8% compared to the S&P 500 Index which fell -13.5%.
Historically, our most significant outperformance has been in down and lower return markets or off the market bottoms after significant declines. In momentum-driven high multiple periods we are not surprised to lag, as we may be more focused on risk at those times than maximizing the return.
Last year, it seemed the main thing that mattered was an accommodative central bank. To start the year, there were rate cuts, followed by significant liquidity injections in the second half of 2019. Corporate earnings were massively disappointing, with the final tally likely showing no growth in earnings and slight growth in earnings per share for the S&P 500 Index. This means that at the end of 2019, the S&P 500 Index was 30% more expensive than it was at the end of 2018, which itself was quite expensive compared to historical valuations.
Apple Inc. (AAPL, Financial) was the largest contributor to S&P 500 Index results last year and a good example of high-octane multiple expansion in action in the absence of business growth. Apple’s share increased nearly 90% last year while its pre-tax earnings for the fiscal year ending September 30 declined. Apple’s earnings are below where they were four years ago, yet the stock sells for about triple its 2015 price. Part of the Apple share price phenomenon is likely due to significant share repurchase, something that has also driven stock prices and multiples for many companies in recent years.
Last year was a busy one for us. We added several new positions in quality companies like Alphabet Inc. (GOOG, Financial) and Booking Holdings Inc. (BKNG, Financial) and increased position weightings in favorite investments like Samsung Electronics Co Ltd Preferred (Samsung) (XKRS:005935) and Bollore SA (XPAR:BOL, Financial). Some of our larger positions like Fox Corp (FOXA, Financial) and Procter & Gamble (PG, Financial) were reduced, with Fox’s due to the successful completion of its merger and P&G’s due to price appreciation. Our position in Avon Products Inc. (AVP, Financial) debt and equity was eliminated after the company agreed to be acquired by Natura Cosmetics.
Top 3 Contributors
Samsung Electronics Preferred (Samsung)
Street Corporation (State Street)
Walt Disney Co. (Walt Disney)
Top 3 Detractors
Oracle Corporation (Oracle)
Hyundai Home Shopping Network
Cisco Systems Inc. (Cisco)
Contributors
Samsung (XKRX:005935, Financial), our largest holding, was the strongest contributor to results in the fourth quarter. The stock rallied due to increasing signs of a bottom in the memory semiconductor markets. Samsung remains inexpensive, with about one-third of its value in excess cash and securities and the shares trading at less than 10x our expectation of 2020 earnings, which is less than 6.5x net of excess cash and investments. We think earnings will rebound solidly in the near term, and the long-term outlook is attractive as there will be greater demand for memory from 5G, artificial intelligence, the internet of things, autonomous driving, and other data applications.
State Street (STT) rebounded more than 30% during the fourth quarter, significantly outperforming the already strong financial services sector. Earlier in the year, the shares had declined in what we thought was an over-reaction to near-term earnings pressures. The stock remains inexpensive, selling at about 12x 2020 earnings.
Disney’s (DIS) stock rose during the fourth quarter due to strong initial subscriptions to its Disney+ service, which is a direct-to-consumer offering. We think Disney is one of the few companies that has the intellectual property, content, and scale to sustain its leadership position in media over the long term.
Detractors
Oracle’s (ORCL) shares struggled after announcing results that showed continued revenue growth challenges. We like the shares because they sell at an attractive price to cash flow and we think the company can produce reasonable returns over time even with modest business results. It wasn’t long ago that Microsoft looked like Oracle today, with many thinking it would never be competitive again, allowing us to build a substantial position and be positively surprised by the company’s resurgence.
Hyundai Home Shopping Network (XKRX:057050) was weaker during the quarter due to concerns that its future commission rates would be negatively impacted by government regulation. The stock is incredibly inexpensive at current prices, possessing significant net cash and attractive public investment holdings which alone account for most of the current market price.
Cisco’s (CSCO) shares were weaker during the quarter due in part to weaker earnings results and lower earnings guidance. While the company faces greater challenges to long-term growth than less established, more exciting growth stories, the stock trades at a significantly more attractive valuation than most of its technology peers.
Conclusion
2019 marked the 30th anniversary of the Japanese market peak, an event that should serve as a reminder that price matters. The Japanese index is about one-third below its 1989 top even though interest rates in Japan are even lower than rates in the United States and the Bank of Japan has been aggressively buying exchange traded funds and will soon be the largest stock owner in the country. Paying high prices for stocks is a bad idea. The good scenario is low long-term returns, and the bad scenario could have an investor waiting half of an adult lifetime or more to make back losses.
In the U.S. markets today, we think index investors have traded or confused the risk of underperforming versus a benchmark with the significant risk of overpaying for the benchmark. U.S. indexing seems like the world’s worst overcrowded trade today, where its owners barely seem to ask the question “What price am I paying and what rate of return do I expect?”
Today’s level of indexing and momentum is almost completely untested in a difficult market or economic downturn. In our opinion, people who are “all in” on index funds and ETFs are signing up to be crash test dummies in a market panic. Perhaps better put by Charlie Munger (Trades, Portfolio), "Some people seem to think there’s no trouble just because it hasn’t happened yet. If you jump out the window at the 42nd floor and you’re still doing fine as you pass the 27th floor, that doesn’t mean you don’t have a serious problem.”
Our goal, as always, is risk-adjusted returns over a full market cycle. While it has been a long time since declines have been part of the cycle, other than 2018’s brief drop, we do not believe that falling prices have been eliminated from equity investing. Due to high valuations, we believe risk management matters more than ever today while the phrase “it’s different this time” is heard frequently as a way to justify the massive multiple expansion that has occurred at a time when earnings results have been poor. The cycle has not been eliminated, and it’s probably not different this time. Rather, it’s a combination of liquidity, momentum, and fear of not keeping up that causes most to ignore risk at the time it needs to be managed most.
The views expressed represent the opinions of Yacktman Asset Management (Trades, Portfolio) LP as of December 31, 2019, are not intended as a forecast or guarantee of future results, and are subject to change without notice.
