Market Overview
In the first quarter of 2018, the MSCI World Index declined -1.28% while in the United States the S&P 500 Index fell -0.76%. In Europe, the German DAX Index dropped -6.35% and the French CAC 40 Index decreased -2.51%. In Japan, the Nikkei 225 Index declined -4.98% over the period. Brent crude oil climbed 5.08% to $70.27 a barrel, and the price of gold rose 1.68% to $1,325.00 an ounce. The US dollar was down -5.69% against the yen and down -2.59% against the euro.
When markets were hitting fresh peaks in January, Wall Street commentary was, generally, very optimistic. Economic momentum was good, and despite tightening by the Fed, real interest rates did not seem high enough to trigger adverse economic effects. However, in February and March, emerging geopolitical and monetary complexities started to weigh on the markets. As readers of these commentaries know, we have been concerned about such complexities for several years now.
We think the most important geopolitical development in the first quarter was China’s decision to remove term limits for its president. We do not know why, at this moment in time, China’s party leadership would overtly embrace such a transi-tion, but it seemed to us to suggest a belief that the country faces sizable challenges that require unquestioned authority from the top. Other geopolitical complexities included Russian activity in the Middle East and elsewhere, Italy’s indeterminate election results, Germany’s weak coalition government and the UK’s ongoing difficulties in negotiating the terms of Brexit. At the end of the day, equities are a residual claim on the economy, and if politics become more complex, we believe the result could be a higher risk premium.
The other complexities we stress are monetary. Money-supply growth is at a seven-year low in the United States and a multi-decade low in China.1 Slowing money-supply growth could present medium-term challenges to nominal growth in the world. We also see the Fed shrinking its balance sheet. Just as quantitative easing had a positive impact on asset prices, we think its reversal could have a negative effect.
During the quarter, markets generally corrected by approxi-mately 10% from their peaks.2 The quarter’s decline came in two distinct phases. The correction in February was unusual in that it was defensive assets—gold, consumer staples, US Treasury bonds—that generally sold off. Rather than a sign of increased risk-aversion, this seemed to represent a fear that growth was going to be very strong and that inflation would surprise on the upside. We think fiscal stimulus (the new US tax law) at the peak of the economic cycle also added to the market’s nervousness. The decline in March was a more familiar kind of downturn, with signs of increased risk-aversion. The rise in bond yields and oil prices, coupled with some of the geopolitical risks, began to weigh on economic sentiment. Treasury yields declined, and the price of gold rose.3
Portfolio Review
As the overall market declined in the first quarter, the Global Fund outperformed the MSCI World Index. The First Eagle Global Fund class A shares (without sales charge) * returned -1.15% versus the -1.28 return of the MSCI World Index. On a sector basis, information technology, telecommunication services, healthcare and industrials contributed to the fund’s first-quarter performance (in absolute terms), and materials, consumer discretionary, consumer staples and energy detracted.
On a regional basis, returns were positive in Japan and devel-oped Asia ex-Japan, and negative in developed Europe, North America and emerging markets. The top contributors for the first quarter were Microsoft Corp., gold bullion, FANUC Corp., Keyence Corp. and Astellas Pharma Inc.
Microsoft (MSFT, Financial)’s transition to a cloud-based business model has provided it with a predictable stream of annuity-like earnings. Microsoft has generated substantial free cash flow and has grown organically at a high-single-digit rate. The market has responded with a higher valuation for the stock.4
Even in a period when the Fed has been raising rates, our posi-tion in gold contributed to quarterly results. Although its price was somewhat volatile, gold generally served as ballast in a relatively choppy market.
A number of Japanese stocks also contributed, including two industrial automation stocks—FANUC, a leader in servo-motors and robots, and Keyence, a specialist in sensors for factory automation. Astellas Pharma advanced after it received a patent extension for one of its key drugs. The strength of the yen during this period also helped the US dollar returns of all three stocks.
The largest detractors for the quarter were Comcast Corp., Sodexo SA, Nutrien Ltd, Exxon Mobil Corp. and Newcrest Mining Ltd.
Comcast (CMCSA, Financial) fell after the company announced a bid for Sky, a UK-based pay-TV company. Historically, Comcast has gener-ally focused on local US markets where it has scale advantages, so the bid for Sky raised questions about a possible shift in Comcast’s business strategy. On the other hand, the company is, potentially, a major beneficiary of the new tax law in the United States.
Shares of Sodexo (XPAR:SW, Financial), a catering and facilities management company based in France, also declined during the quarter. In our view, Sodexo’s new CEO reset expectations to a more conservative level at a stage in the economic cycle when there can be a mismatch between the company’s labor-sensitive costs and its concentrated revenues. Given tighter labor markets, Sodexo has experienced labor-cost inflation in some areas, and because of multiyear service contracts, it cannot immediately pass these costs on to customers. We believe the company’s businesses are stable and have generated considerable cash flow. We have been a long-term owner of the stock.
Some stocks representing defensive real assets were also a little soft. These include Exxon and Nutrien—a Canadian fertilizer company created from the merger of Potash Corporation of Saskatchewan and Agrium. Exxon’s stock declined following the release of fourth-quarter results. Investors were disappointed that higher oil prices did not translate into a greater increase in cash flow. We did not see these results as cause for concern. Exxon’s business mix includes downstream operations that use oil as an input, and it also has production-sharing agreements (PSAs) with states around the world that can cause volumes to go down when prices go up.
Newcrest, a global gold-mining company based in Australia, was weak on concerns about a breach in the wall of a tailings dam at one of its Australian mines. We are closely monitoring this situation.
Overseas Fund
The First Eagle Overseas Fund Class A shares (without sales charge)* returned -1.10% versus the MSCI EAFE Index of -1.53%. Sectors contributing to quarterly performance included healthcare, telecommunication services and information technology, and sectors detracting included materials, consumer staples and energy. On a regional basis, Japan and developed Asia ex-Japan contributed to returns, and developed Europe, North America and emerging markets detracted.
The top contributors for the first quarter were Haw Par Corp. Ltd, Keyence Corp., FANUC Corp., gold, and Robertet SA.
Haw Par (SGX:H02, Financial) is a Singapore-based holding company that holds meaningful stakes in a large Singaporean bank, a major Singa-porean property developer and a topical analgesic known as Tiger Balm. Its cash holdings are also considerable, in our judg-ment. Haw Par has a combination of real and financial assets, and we believe it has traded at a meaningful discount to the sum of its parts. The stock gained after the company restructured some of its assets in 2017.
A number of Japanese stocks also contributed, including two industrial automation stocks—FANUC, a leader in servo-motors and robots, and Keyence, a specialist in sensors for factory automation. The strength of the yen during this period also helped the US dollar returns of both stocks.
Even in a period when the Fed has been raising rates, our posi-tion in gold contributed to quarterly results. Although its price was somewhat volatile, gold generally served as ballast in a relatively choppy market.
The largest detractors for the quarter were Nutrien Ltd, Finan-ciere Bluele LLC., Sodexo SA, Nestle S.A., and Imperial Oil Ltd.
Some stocks representing defensive real assets were also a little soft, including Nutrien—a Canadian fertilizer company created from the merger of Potash Corporation of Saskatchewan and Agrium.
Shares of Sodexo, a catering and facilities management company based in France, also declined during the quarter. In our view, Sodexo’s new CEO reset expectations to a more conservative level at a stage in the economic cycle when there can be a mismatch between the company’s labor-sensitive costs and its concentrated revenues. Given tighter labor markets, Sodexo has experienced labor-cost inflation in some areas, and because of multiyear service contracts, it cannot immediately pass these costs on to customers. We believe the company’s businesses are stable and have generated considerable cash flow. We have been a long-term owner of the stock.
Imperial Oil (IMO, Financial), an Exxon subsidiary in Canada, declined in value as spreads widened between Canadian oil prices and such benchmarks as the WTI Index. Over the longer-term, these spreads tend to mean-revert as pipeline capacity is added to deliver Imperial’s output to the US market. Imperial has also reduced its operating costs.
U.S. Value Fund
The First Eagle U.S. Value Fund Class A shares (without sales charge) * returned -0.75% versus the -0.76% return of the S&P 500 Index.
The top 5 contributors were Microsoft Corporation, gold bullion, Alleghany Corporation, Varian Medical Systems, and Xilinx, Inc.
The top 5 detractors were Comcast Corporation, Synchrony Financial, Nutrien Ltd., Newcrest Mining and Oracle Corporation.
We appreciate your confidence and thank you for your support.
First Eagle Investment (Trades, Portfolio) Management, LLC
