Market Overview
The move down in long-term interest rates in recent quarters has shed an ominous light. We’ve seen the yield curve invert in the United States, and there is evidence of softening in the underlying economy. The manufacturing sector has been weak globally, and momentum in the service sector has started to fade. In the United States, services account for more than twothirds of the economy, and weakness here can have a deleterious effect; we’ve seen signs of this in a year-over-year deceleration in average hourly earnings and potentially a third consecutive quarterly decline in S&P 500 earnings growth once third quarter results are tabulated. The United States had been the bright spot in the global picture, but it has begun to dim, and the world economy appears to have stalled.
This slowdown is attributable to a number of headwinds, all of them having emerged amid a backdrop of elevated debt levels globally. One is the lag effect of Federal Reserve monetary tightening, the bulk of which took place in 2017 and 2018, and the deceleration in money supply growth that accompanied it. Another is the fact that the US economy appears to have cycled through the fiscal stimulus that was introduced in late 2017 and 2018.
Heightened geopolitical uncertainty also has been impactful. As we have noted for some time, the current environment is one in which global and local political developments can outweigh normal business cycle fundamentals. Perhaps most notable has been the US trade disputes with China and others; the concern here is not just the negative impact of tariffs on certain industries, but also the broader uncertainty that can undermine CEOs’ confidence as they formulate capital spending plans. In addition, we saw a move toward the impeachment of President Trump in the United States, while the UK’s Brexit plans have been further complicated by the emergence of various constitutional challenges. In September a drone attacked Saudi Arabia’s oil production facilities, halving their output. Hong Kong has experienced dramatic and persistent protest activity in recent months, and its economy, which is very important for China and the rest of the region, is going through a soft patch.
It’s also noteworthy that a host of significant banks around the world have depressed stock prices. These stocks have fallen, in large part, because low interest rates have limited the banks’ ability to profit from their fundamental business of lending. Yet banks are also the transmission mechanism for monetary policy. If easing—especially into negative territory—is damaging to banks, how efficacious can it be? Are central banks effectively pushing on a string?
Nevertheless, central banks have continued to move toward an easier posture in response to the weaker economic data. During the quarter, the European Central Bank lowered rates further into negative territory. In the United States, the Fed cut its benchmark rate and appears biased toward additional easing, driving the price of gold higher. (Historically, the gold price and real interest rates have been inversely related.) The Fed also introduced a $75 billion liquidity facility in response to a breakdown in the market for repurchase agreements; in the repo market, banks and certain other financial concerns extend very short-term loans to one another in exchange for safe collateral, typically Treasuries. We were troubled by this evidence that after just a short period of quantitative tightening, liquidity pressure started to build in the US banking sector.
It’s interesting to us that Fed Chairman Jay Powell now speaks about 2% inflation as a symmetrical target—meaning that inflation above 2% would now be desirable to offset the long period of time when it was below 2%. With both realized inflation and inflation expectations persistently below target in many major economies, future interventions by central banks and world governments may take less conventional forms. Government experimentation with untested economic theories strikes us as perilous, however.
Softer economic conditions have not driven the investment markets down as much as one might have anticipated. This is probably due to investors’ expectations of easier monetary conditions, as lower real interest rates often have a positive impact on the prices of assets, whether equities or gold. Though equities as a whole have levitated at a reasonably high level, decent segments of the market have de-rated underneath the surface, in some cases creating interesting investment opportunities.
Portfolio Review
Global Fund
The Global Fund delivered a positive return in the third quarter, outperforming the MSCI World Index. The First Eagle Global Fund Class A shares (without sales charge)* returned 0.90% versus the 0.53% return of the MSCI World Index. On a regional basis, Japan contributed strongly while developed Asia ex-Japan, North America and developed Europe detracted. On a sector basis, materials, financials, communication services and consumer staples led the way, while energy and industrials were significant detractors.
Leading contributors to the Fund’s performance in the second quarter included gold bullion, Comcast Corporation, Sompo Holdings, Weyerhaeuser and Alleghany.
The third quarter increase in the price of gold was off its second quarter pace, but this position was large enough to produce a sizable impact on portfolio performance.
Comcast has been a puzzle for investors for some time. While its cable-TV business has been declining as consumers abandon their cable connections in favor of streaming content, its broadband business has grown as these cord-cutters turn to Comcast for the necessary internet service. Further, Comcast’s costs for servicing its customers have been lower than many observers expected, and its margin improvement has been notable.
Sompo, a Japanese property-casualty insurance company, benefited from improving conditions in the global insurance marketplace. A number of factors, including poor returns from insurers’ fixed income holdings and losses related to catastrophes, have led to some hardening of property-casualty insurance rates.
Weyerhaeuser posted better than Street-expected earnings in the second quarter, driven by its core timberlands segment. In addition, September saw the company agree to sell 555,000 acres of land in Michigan for, in our view, a reasonable price.1 Notably, at its low point in the quarter the stock yielded as much as 5.6%—a dividend that may have proved tempting to investors in an otherwise yield-starved environment.
Alleghany Corporation is a holding company with a number of insurance businesses in its portfolio. Alleghany’s shares advanced following the emergence of pockets of strength in insurance pricing.
The leading detractors in the third quarter were Schlumberger, Jardine Matheson, Exxon Mobil, Teradata and Flowserve.
Shares of Schlumberger, an oilfield services company, declined as the price of oil fell in the third quarter.
Jardine Matheson, a conglomerate with key assets primarily in Southeast Asia, saw its stock decline because of the continuing protests in Hong Kong, where it has its headquarters and major real estate holdings.
Shares of Exxon Mobil declined along with the price of oil in the third quarter.
Teradata, a US-based provider of database software and analytics, declined in the period despite improvements in its underlying business. Investors have been slow to recognize the promise of the company’s transition from a traditional sales model based on licensing to one driven by subscriptions.
Texas-based Flowserve, which produces and services pumps, seals and valves flow-control products, derives a large share of its revenues from energy-related end markets and traded lower with the decline in oil prices during the quarter.
Overseas Fund
The First Eagle Overseas Fund Class A shares (without sales charge)* returned 0.87%, outperforming the MSCI EAFE Index which returned -1.07%. Developed Europe, Japan and North America made the largest contributions and emerging markets detracted slightly. On a sector basis, materials, information technology and communications services stood out, while real estate and industrials detracted.
Leading contributors to the Fund’s performance in the third quarter included gold bullion, Sompo Holdings, NTT DoCoMo, Secom and SMC Corporation. The leading detractors in the second quarter were Jardine Matheson, Compania Cervecerias Unidas, Hysan Development, Great Eagle Holdings and Compagnie Financiere Richemont.
Please see Global Fund Portfolio Review for comments on gold bullion, Sompo Holdings, and Jardine Matheson.
NTT DoCoMo is one of three established players in Japan’s mobile phone market, all of which were challenged by the entrance of a fourth participant. However, investors have started to recognize that the new competitor may have a difficult time meeting the low-cost expectations in this marketplace. NTT DoCoMo had the benefit of a relief rally in the third quarter.
Secom, a Japanese security company, has experienced business growth related to Japan’s hosting of both the Rugby World Cup in 2019 and the Summer Olympics in 2020—events that have spurred demand for Secom’s commercial security equipment.
SMC is a Japanese producer of pneumatic equipment used in industrial automation. The market seems to have started to look through some of the cyclical headwinds SMC is facing in several of its end markets, anticipating a recovery in demand. Moreover, SMC recently underwent a change in leadership, which could drive more shareholder-friendly capital allocation going forward.
Compania Cervecerias Unidas (CCU) is a leading brewery and soft-drink company based in Chile. Copper is Chile’s main export, and the Chilean economy has suffered as economic strains in China have reduced the country’s appetite for the metal. CCU’s shares were caught up in investor flight from Chilean equities, even though its business fundamentals remained intact.
Shares of Hysan Development, a large real estate firm in Hong Kong, declined because of the continuing protests in Hong Kong.
Hong Kong-based Great Eagle is a real estate company with a primary focus on hotel ownership and operation. Though its portfolio of properties is globally diversified, continued protest activity has hobbled economic activity and market sentiment in Hong Kong, hurting Great Eagle.
Richemont is a luxury goods holding company based in Switzerland. It has substantial sales in Hong Kong, and the continuing turmoil there had a negative impact on its shares.
U.S. Value Fund
The First Eagle U.S. Value Fund Class A shares (without sales charge)* returned 0.48% versus the 1.70% return of the S&P 500 Index in the third quarter. Sectors contributing positively to quarterly performance included financials, materials, communications and real estate, with energy, industrials and health care detracting.
The top contributors were gold bullion, Alleghany Corporation, Comcast, Weyerhaeuser and BB&T Corporation. Detractors included Anthem, Exxon Mobil, Teradata, Flowserve and Schlumberger.
Please see Global Fund Portfolio Review for comments on gold bullion, Alleghany Corporation, Comcast, Weyerhaeuser, Exxon Mobil, Teradata, Flowserve and Schlumberger.
BB&T, which is poised to complete its merger with SunTrust by the end of 2019, reported solid results for the second quarter in mid-July. Most of its quarterly gain occurred in September, however, as some steepening in the yield curve provided a bit of relief for bank stocks.
US-based health insurer Anthem lost value as news of the impeachment process came to the fore. On the assumption that both Trump and Democratic contender Joe Biden will be tarnished by this process, investors began to consider the potential impact of a presidential victory by Elizabeth Warren, who has argued for the abolition of private health insurance.
We appreciate your confidence and thank you for your support.
Sincerely,
First Eagle Investment (Trades, Portfolio) Management, LLC
1. Source: Bloomberg.
*Performance for Class A shares without the effect of sales charges and assumes all distributions have been reinvested, and if a sales charge was included values would be lower.
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%.
* The annual expense ratio is based on expenses incurred by the Fund, as stated in the most recent prospectus.
** These are the actual Fund operating expenses prior to the application of fee waivers and/or expense reimbursements. The Adviser has contractually agreed to waive its management fee at an annual rate in the amount of 0.05% of the average daily value of the Fund’s net assets for the period through February 29, 2020. This waiver has the effect of reducing the management fee shown in the table for the term of the waiver from 0.75% to 0.70%. S&P 500 Index is a widely recognized unmanaged index including a representative sample of 500 leading companies in leading sectors of the US economy and is not available for purchase.
The commentary represents the opinion of the Global Value Team portfolio managers as of September 30, 2019, and is subject to change based on market and other conditions. The opinions expressed are not necessarily those of the entire 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 or sell or the solicitation of an offer to buy or sell any fund or security.
