Market Commentary
In our year-end 2019 commentary we talked about the impor-tance of portfolio balance given our wariness of the indicators suggesting 2020 could be a very good year for equities. While we noted that an exogenous shock could throw upbeat market calculations askew, neither we nor anyone else anticipated the emergence of a global pandemic that would exert a powerful impact on markets and economies.
All US equity indexes in first quarter 2020 saw declines of greater velocity than that witnessed during the financial crisis of 2008–09. There were non-surprises; economically sensitive names suffered, for example, while those that are less economi-cally dependent held up substantially better. The entire energy sector was decimated by a second “black swan” event—the oil supply war between Saudi Arabia and Russia—in tandem with the demand shock of the novel coronavirus. There also were surprises, businesses that ordinarily behave more defensively but saw their stock prices fall in line with the market during the first quarter. For the Fund’s portfolio these names were primarily concentrated in the healthcare and the consumer “need to have, rather than nice to have” sectors.
As always in times of economic crisis, our concern is that liquidity issues at a company may become a solvency issue. Stress-testing balance sheets is a continuous exercise; for companies the Fund holds, we consider whether debt matu-rity schedules appear well-placed and -timed. Our interaction with management teams of the Fund’s holdings has increased noticeably during the last month, from an already-high level. Managements are focused on the safety of their employees, their balance sheets, maintaining adequate liquidity and operational excellence. Though we are only in the early stages of a crisis that no corporate management team has faced previously, we believe teams’ strength will become apparent in the months ahead and be reflected in their share prices.
In assessing the Fund’s portfolio, we have looked at its holdings in the context of the pandemic-related economic shutdown and evaluated both 1) the temporal impact on operations and 2) the longer-term competitive opportunity. Through this prism we have attempted to discern risk/reward and where we should be allocating capital. We have harvested stocks where we felt the risk of longer-term impairment was too great relative to the stock decline, directing the proceeds toward names that may have experienced similar declines but in our view appear better positioned to weather the crisis and emerge from it with a strong hand.
Of course, integral to estimating future returns will be gauging the economy’s ability to return to normalcy in a timely fashion. Our current base case is that the US hits a peak in Covid-19 diagnoses in late April/early May and gradually starts to get back to work before Memorial Day. Even in this scenario, however, many sectors of the economy will be very slow to return to any degree of normalcy. Additionally, the specter of a seasonal return of Covid-19 remains significant. A full return to a pre-Covid-19 economic environment will require public confidence in either therapeutic protocols that can significantly diminish the fear factor and/or a vaccine.
The equity market movements thus far in early April would appear to reflect some of this base case. Of course, bear markets rarely end after a single substantial decline, and markets may indeed move lower in the coming months. Still, we believe that the Fund’s portfolio trades with a normalized free cash flow yield in at least the high single digits, which seems reasonable in the current TINA (“there is no alternative”) environment of 10-year Treasuries below 1%. Typically, when equity free cash flow yields are so high above risk-free returns in the absence of near-term inflation, equity valuations skew positive over the next several years. We will have to see if that is the case in the current environment.
Portfolio Commentary
Fund of America Class A shares (without sales charge*) returned -23.72% in first quarter 2020. All market sectors detracted from performance in what was a very challenging period for equities; as was the case in the last major market downturn, midcap stocks lagged large-cap stocks by a wide margin. Fund of America underperformed the S&P 500 Index in the period.
Leading contributors to the Fund’s performance in the fourth quarter included Perrigo Company plc, Halozyme Therapeutics, Inc., Bloom Energy Corporation, DaVita Inc. and nVent Electric plc.
The largest US manufacturer of over-the-counter medicine, Perrigo (PRGO, Financial) benefitted from consumers stocking up on these medica-tions during the quarter. Our thesis on Perrigo continues to be that the market appears to undervalue the franchise due in large part to an overhang from legacy tax issues and that new CEO Murray Kessler is seeking to transform the company into a growing consumer healthcare franchise.
Halozyme Therapeutics (HALO, Financial) contributed to performance during the quarter as the market seemed to recognize the potential value of the company’s future royalty streams. Consistent with our investment thesis, the company terminated its proprietary pancreatic cancer trials in fourth quarter 2019, significantly reduced operating expenses and has begun to return cash to shareholders.
Bloom Energy (BE, Financial) and its hydrogen fuel cell peers performed very well early in 2020, as investors appeared to develop greater appreciation for the potential of fuel cell technology in an environment of falling natural gas prices. Bloom gave back all of this performance and more mid-quarter, however, as a financial restatement that delayed the release of their 2019 10K compounded the impact of the general coronavirus-related market selloff. A better-than-feared fourth quarter earnings report, which showed 50% growth in system acceptances, prompted a late-March rebound.
DaVita (DVA, Financial), which operates kidney dialysis centers with a focus on the US, reported better-than-expected fourth quarter 2019 earnings and gave solid guidance for 2020 while continuing to repurchase its own shares.
A top global provider of electrical connection and protection solutions, nVent (NVT, Financial) was volatile in the first quarter, like many of its industrial peers.
The leading detractors in the quarter were Wyndham Destinations, Inc., Marathon Petroleum Corporation, Wyndham Hotels & Resorts, Inc., Post Holdings, Inc. and Martin Marietta Materials, Inc.
Like virtually all travel-related stocks, Wyndham Destinations (WYND, Financial) and Wyndham Hotels and Resorts (WH, Financial) were down sharply during the quarter on Covid-19 concerns. Both companies withdrew their full-year guidance in March and closed resorts due to the pandemic.
Pervasive weakness across the energy sector, and in global refining markets and crack spreads specifically, pulled down Marathon Petroleum (MPC, Financial) during the quarter. The stock was further hurt by early-March news that Japanese retailer Seven & i Hold-ings was scrapping plans to acquire Marathon’s Speedway gas station/convenience stores for $22 billion.
Though Martin Marietta (MLM, Financial) stock declined in the quarter due to concerns about the near-term effect of the coronavirus pandemic on construction and demand for aggregates and cement, we believe the impact will likely be temporal and not as bad as the market fears. Notably, the consolidation of the aggregates market has led to rational pricing in most of the regions in which Martin Marietta operates.
Post (POST, Financial) detracted in the quarter, as the company’s prepared-egg business—which historically has primarily served fast-food customers such as McDonalds—has been hurt in the near term by the pandemic. The company has temporarily shifted some of its egg production to retail supermarkets given the strong demand and is also seeing very solid demand for much of the remainder of its food portfolio, including cereals, frozen meals and shelf-stable protein shakes. We continue to believe the shares of Post are undervalued based on our estimate of their intrinsic value.
Thank you for your continued support,
Sincerely,
First Eagle Investment (Trades, Portfolio) Management, LLC
The performance data quoted herein represent past performance and do 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 principal 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 are 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 Fund of America give effect to the deduction of the maximum sales charge of 5.00%.
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 to buy, hold or sell or the solicitation or an offer to buy or sell any fund or security.
