Market Overview
While 2020 as a whole was a generationally difficult year for value investors, signs of a "reflation" trade that emerged in September persisted through year-end, driving the outperfor-mance of value both globally (15.7% for the MSCI World Value versus 12.5% for MSCI World Growth) and within the US (16.3% for Russell 1000 Value versus 11.4% for Russell 1000 Growth) during the fourth quarter. Similarly, the full year underperformance of international stocks was trimmed some-what, as the MSCI EAFE Index outpaced the S&P 500 Index 16.0% to 12.1%, due in part to a weakening US dollar.1
Of course, the 12-month picture tells a much different story in a year when lockdowns drove the virtual economy up and the real economy down. While the MSCI World Index was up 15.9%, the growth component returned 33.8% compared to a 1.2% decline in value; this 35% spread almost defies belief given that the growth and value indexes have a long-term historical correla-tion in excess of 0.9. Spreads between growth and value were similar in the US, as the Russell 1000 Growth Index posted a 38.5% return during 2020 compared to the 2.8% return of the Russell 1000 Value Index.2
The pandemic provoked a near shutdown of the more mature, physical components of the economy—such as commodities, manufacturing and real estate—which include companies that tend to populate value indexes. In contrast, the pandemic-driven shift online for both business and personal commerce accelerated preexisting trends and provided a significant boost to the revenue and cash flows of new economy growth stocks with strong online presence. Despite the impressive business results posted by certain elements within the growth space, overall index performance in 2020 was driven primarily by multiple expansion. By year-end, the enterprise value/EBIT ratio of the MSCI World Growth Index relative to the MSCI World Value Index stood at the highest level since 2000.3
As long-term investors, we think it is important to take the right message from the strong broad market returns in 2020. As we've often cautioned, extrapolating trends is a risky way to commit capital, particularly when these trends reflect an extraordinary operating environment like that in 2020. Some of the factors that led to the extreme gap in valuation between growth and value last year have a natural elasticity to them and are likely to revert. The arrival of vaccines suggests there is a plausible path for economies to reopen within the next 12 months, to the potential benefit of the companies most directly impacted by 2020's lockdowns—mature businesses operating in the physical economy. Further, more-normal conditions may make it difficult for certain growth stocks to maintain lofty valuation multiples as year-over-year sales and earnings growth comparisons become more challenging in 2021.
Low discount rates also have heightened the appeal of more speculative names, as investors see less opportunity risk in taking a flyer on investments that may pay big rewards down the line— or nothing at all. Frankly, we are concerned about the signs of speculative froth we see in paradoxically low credit spreads, in the torrid initial public offering market (including offerings of special-purpose acquisition companies, or SPACS) and in the many "concept" stocks that trade at valuations divorced not just from the reality of their current cash flows or revenue but also from any plausible expectation for five years from now.
Yellow Signals Ahead?
We believe that market and monetary dynamics have reached a pivot point and that we could be heading into a period of signifi-cant risk for investors.
If we analyze the pattern of money supply over the past 50 years—from the dissolution of the Bretton Woods agreement in 1971, to the deflationary impact of China's entry in the global economy in the 1990s to any number of economic dislocations from such events as the dot-com bubble, the global financial crisis and Covid-19—we see a significant transition. While currency and government debt had once been exogenously constrained by either a link to gold or by a tough, independent central bank, it now is endogenously created to support fiscal deficits and private sector recapitalization, seemingly without fear of repercussion. This may seem like a free lunch, but there is no free lunch in economics.
With relatively fixed money supply, business cycles can be deeper, restructuring harsher and inequality greater, but there is less inflation and limited fiscal and trade imbalances, and longer-term productivity growth tends to be higher as a result. Without such constraints, short-term cycles are cushioned—as we saw most recently during the onset of Covid-19—but at the expense of growing monetary, fiscal and trade imbalances, which all act as headwinds to longer-term productivity. These conditions ultimately may be exposed as a global bifurcation: on one side are regions with strong currencies and trade surpluses—like Japan and Europe and potentially even China in the years ahead—that may face deflation risk; on the other side are weak-currency, trade-deficit regions—like the US and the UK—that may be subject to stagflation risk. Net net, this paints a picture of struc-turally lower real returns for the market portfolio and lower real productivity growth with the illusion of macro stability.
The True North
Though the dollar was strong early in 2020 as investors sought perceived currency "safe havens," it has weakened steadily once risk assets began to rebound in late March and real interest rates—the difference between nominal rates and inflation— headed south. As the Fed slashed its policy rate to near zero, interest rate differentials between the US and other nations shrank, diminishing the appeal of the dollar carry trade. Mean-while, through its embrace of an inflation-averaging frame-work rather than a hard 2% target, the central bank will let the economy run hot to make up for many years of sub -target inflation. We think the combination of a weaker dollar and lower-multiple international equity markets creates a more favor-able backdrop for us as global investors.
Gold also proved to be a useful hedge against the economic shock and the concurrent monetary debasement we witnessed in 2020. Gold hit a new high in nominal US dollars during the year, reflective of lower real rates and a weaker dollar. We don't have a directional view on gold, but it is important to set realistic expectations for gold in 2021. A stronger-than-expected recovery could inspire more-hawkish rhetoric from the Fed and lead to a stronger dollar and a backup in bond yields, likely impairing the value of gold. Having said that, we are maintaining a somewhat larger-than-average allocation to gold as a potential hedge to help chart a resilient course through a complex environment. High equity market valuations and sovereign debt levels are potentially destabilizing factors, as are both global and local politics. With sovereign rates likely to remain near zero as the money supply continues to grow unabated, cash is a less-appealing alternative to gold, especially if central bank efforts to promote inflation are successful. Finally, we are mindful of the new strains of Covid that have been emerging alongside the original strain whose impact has worsened through the winter.
True north for us remains the quest for sound real returns against the backdrop of a complex, unpredictable world. The rearview mirror shows a pattern of sound, resilient real returns for our strategies, which have neither been as weak as distressed markets nor as strong as the pockets of maximum speculative interest. The forward view is one where expectations for broader asset returns should be tempered, given high valuations and/ or low yields amid structural risks from sovereign debt levels to geopolitics, monetary experimentalism and the ongoing pandemic. The quality and diversity of our stock holdings gives us conviction against this backdrop. Some may participate in the new economy, some will potentially benefit from a recovery of the more mature physical economy, and some are simply grind-it-out cash-flow-generative businesses—but all are quality businesses at prices we consider sound.
Our approach to value investment begins with defining the character of a business before assessing its price. We believe owning soundly valued, real businesses and a potential hedge in gold is a prudent way to participate in the market's upside while making sure we can endure the pockets of distress that we will likely encounter.
First Eagle Global Fund
Global Fund A Shares (without sales charge*) posted a return of 11.00% in fourth quarter 2020. North America was the biggest contributor from a geographic standpoint, though performance was positive in all regions. Financials were the biggest contributor among economic sectors, followed by industrials, information technology and consumer discretionary; while no economic sectors detracted, utilities lagged. The Global Fund underperformed the MSCI World Index in the period.
Leading contributors in the First Eagle Global Fund this quarter included FANUC Corporation, Compagnie Financière Richemont SA, Taiwan Semiconductor Manufacturing Co., Ltd., Exxon Mobil Corporation and Comcast Corporation.
Improving business sentiment worldwide, particularly in Asia, served as a tailwind for the shares of factory automation company Fanuc (TSE:6954, Financial). The stock has been very strong this year, more than doubling off its March lows, but we think the value Fanuc adds to manufacturing processes through its technologies— including computer numerical control, robots and cobots—positions the company to potentially deliver shareholder value over the long term. Having increased capacity substantially at the end of the last cycle, Fanuc appears to have latent earnings power that may be revealed once the new cycle fully blooms.
Luxury conglomerate Compagnie Financière Richemont (XSWX:CFR, Financial) benefitted from renewed demand for its range of high-end watch and jewelry brands, including Cartier, Jaeger-LeCoultre and IWC Schaffhausen. Richemont is well capitalized and has been improving its margins steadily. Its most-recent earnings report demonstrated the benefits of its strong presence in the Chinese luxury segment, a market it seeks to further penetrate through a newly announced digital partnership with Alibaba and Farfetch.
As a foundry, Taiwan Semiconductor (TPE:2330, Financial) (TSMC) manufactures chips designed by other companies rather than under its own brand. Shares of TSMC have been fueled by rising structural demand for its products as 5G technology and cloud computing continue to proliferate. Ongoing delays in Intel's fabrication upgrades have been another tailwind for TSMC, as we believe it is well positioned both to potentially win outsourcing contracts for Intel's next-gen chips and to take market share from the American company. TSMC already produces certain chips for Intel, as well as fabless companies like Advanced Micro Devices and Apple.
While demand for oil, as a consumable, tends to be relatively stable during times of recession, the Covid-19 lockdowns had a massive impact on the aviation industry and on auto miles driven, causing demand to decline far more than it did during the global financial crisis. Positive news on vaccines and signs of economic recovery have helped oil demand rebound and prices stabilize, boosting shares of well-entrenched energy companies like Exxon Mobil (XOM, Financial) in an environment of underinvestment and generationally low rig utilization. Exxon Mobil also has seen some encouraging signs of improvement in certain of its chem-ical businesses and progress in its offshore drilling projects in Guyanese waters.
Media and telecommunications giant Comcast (CMCSA, Financial) had an interesting 2020. On one hand, its broadband cable business—which accounted for more than 50% of Comcast revenue in pre-Covid 2019—thrived in a world increasingly dependent on internet connectivity. This tailwind was a headwind in other areas of its operations, however, especially NBCUniversal (composed of cable networks, broadcast television, theme parks and other assets), which struggled amid closures of theme parks and movie theaters worldwide and the loss of advertising revenue from postponed sporting events (including the Olympics). Given its diversified sources of revenue, we view Comcast as a resilient business with a high-quality management team focused on the long-term success of their franchise in an industry subject to potential technological and regulatory shifts. In the near term, meanwhile, theme parks and advertising revenue should recover as economic activity picks up.
The leading detractors in the quarter were C.H. Robinson Worldwide, Inc., Barrick Gold Corporation, Wheaton Precious Metals Corp, Salesforce.com, Inc. and Newcrest Mining Limited.
North America's largest freight broker, C.H. Robinson (CHRW, Financial), was among the portfolio's top performers in the third quarter as truck freight pricing continued to recover from dislocations earlier in the year. The relative weakness in the fourth quarter appears to reflect the market's anticipation that truck and driver supply would expand to meet the ongoing improvements in demand, causing pricing to soften. We remain impressed by C.H.Robinson, which maintains significant scale advantages over its competitors and has delivered consistent revenue growth over the past decade, despite the cyclicality of its business.
Since peaking in early August, the price of gold was on a generally declining trend for the balance of the year as real interest rates picked up. While easing gold prices weighed on the stock prices of miners during the quarter, the quality names we seek to own—including Barrick Gold (GOLD, Financial), Wheaton (TSX:WPM) and Newcrest (ASX:NCM)—have maintained a disciplined approach to capital deployment and balance-sheet management. We believe this reflects the fact that many industry assets have been consolidated into the hands of operators with truly professional management. These well-run companies have bolstered their balance sheets in recent years, positioning themselves to weather changes in the gold price, which can be volatile in the near term.
A strong performer for most of the year, shares of salesforce.com (CRM) in the fourth quarter were weighed down by its acquisition of messaging service Slack for a price that drew concern from some investors. While the market responded negatively to the price salesforce.com paid—especially on the heels of its 2019 acquisition of analytics platform Tableau—the company has continued to execute on its strategy and has evolved over the past several years into the dominant player in customer relationship management.
First Eagle Overseas Fund
Overseas Fund A Shares (without sales charge*) posted a return of 10.07% in fourth quarter 2020. Industrials were the biggest contributor among economic sectors, followed by consumer discretionary, financials and consumer staples; while no economic sectors detracted, transportation and communications services lagged. The Overseas Fund underperformed the MSCI EAFE Index in the period.
Leading contributors to the Fund's performance this quarter included FANUC Corporation, Jardine Matheson Holdings Limited (LSE:JAR), Compagnie Financière Richemont SA, Imperial Oil Limited (TSX:IMO) and Taiwan Semiconductor Manufacturing Co., Ltd..
Detractors included Barrick Gold Corporation, Wheaton Precious Metals Corp, Newcrest Mining Limited, Agnico Eagle Mines Limited (TSX:AEM) and Newmont Corporation (NEM).
First Eagle U.S. Value Fund
U.S. Value Fund A Shares (without sales charge*) posted a return of 11.26% in fourth quarter 2020. Contributors to performance were found broadly across sectors, led by financials, energy and information technology; while no economic sectors detracted, utilities and holding companies lagged. The US Value Fund underperformed the S&P 500 Index in the period.
Leading contributors to the Fund's performance this quarter included Deere & Company (DE), Comcast Corporation, U.S. Bancorp (USB), Bank of New York Mellon Corporation (BK) and Exxon Mobil Corporation.
Detractors included C.H. Robinson Worldwide, Inc., Barrick Gold Corporation, Salesforce.com, Inc., Willis Towers Watson Public Limited Company (WLTW) and Newcrest Mining Limited.
We appreciate your confidence and thank you for your support.
Sincerely,
First Eagle Investment (Trades, Portfolio) Management
- Source: FactSet; data as of January 5, 2021.
- Source: FactSet; data as of January 5, 2021.
- Source: Bloomberg; data as of January 5, 2021.
The performance data quoted herein represent past performance and do not guarantee future results. Market volatility can dramatically impact a 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 Global, Overseas and U.S. Value Funds give effect to the deduction of the maximum sales charge of 5.00%.
