First Eagle Global Fund commentary for the first quarter ended March 31, 2015.
Market Overview
In the first quarter of 2015, the MSCI World index rose 2.31% while in the U.S. the S&P 500 index increased 0.95% and in Japan the Nikkei 225 index increased 10.04%. In Europe, the German DAX and the French CAC 40 indices rose 4.56% and 7.99%, respectively. Crude oil fell 10.64% to $47.60 a barrel, and the price of gold declined -0.07% to $1,183.68 an ounce by quarter-end. The U.S. dollar rose 0.03% against the yen and 12.70% against the euro.
Despite buoyant international equity markets as we enter the new year, our fundamental concerns have not been alleviated. In the developed markets, we continue to worry about historically high debt levels relative to gross domestic product—particularly now that flattening yield curves point to slower future growth in GDP. At the same time, regions with the weakest economic performance, such as Europe and Japan, have been trying to export their deflation, via weak currencies, to the U.S. and other stronger markets.
We are also mindful that the recovery in the U.S. has not been as robust as it may appear. In the past, a steep drop in unemployment from 10% to 5.5% would have indicated economic growth well above the average 3% U.S. pace. But over the past five years, the U.S. economy has grown at just 2%-3%1, implying trend growth below 2%2. An appreciating dollar could present a sizable challenge against this backdrop of tepid trend growth. We’re already seeing signs that the dollar’s strength is cutting into corporate profits. Meanwhile, dramatic cutbacks in capital expenditures in energy and other sectors exposed to lower commodity prices will likely echo throughout the economy. However, low household savings rates mean the positive impact on disposable income from declining gas prices may not flow through to consumption.
Outside the U.S., the slowdown in emerging markets appears to be persistent, with particular weakness in commodities. Growth is very sluggish in Brazil, iron ore prices are hitting new lows, and property values are falling in China. But despite the economic strains, stocks in China have generally performed well—largely because investors anticipate easier monetary policy ahead. Given the immense amounts of debt China has incurred in the past five years to fund its spending boom, this expectation may not be realistic. If China now decides to let its currency weaken, the impact, coming on top of a weaker yen and euro, would be a deflationary pulse to the United States.
From a global policy standpoint, negative real interest rates are really a tax on prudence. People who deposit cash or hold low-risk bonds may see their real wealth erode, and people who take on leverage and swing for the fences in riskier assets may do reasonably well, at least for a while. When prudence is taxed, the outcome is usually an upsurge in imprudence. The illusion of stability that we get from easy monetary policy will likely generate its own instability.
First Eagle Global Fund: Portfolio Review
During the first quarter, our purchases moderately outweighed our sales, and the net effect was a small reduction in our cash position. The market continues to offer sporadic value in certain pockets, which has become a bit more disparate as certain commodities have weakened and related sectors, like the industrials, have weakened along with them. Companies that missed earnings were generally punished more harshly, giving us a window to acquire businesses we liked.
During the quarter, we unwound nearly all of our hedges against the yen and the euro, which had been in place for several years. In comparison with its average relative real value of the past 15 years, the dollar had moved dramatically from being cheap relative to the yen and euro to being expensive. Although we could not rule out further appreciation in the dollar, we believed most of the valuation support for the dollar rally was behind us. Europe and Japan have employed quantitative easing only because their money supply growth has been persistently lower than in the United States. The fact that the Eurozone and Japan were both current-account surplus economies while the U.S. was in current-account deficit further diminishes the dollar’s long-term appeal. In contrast to the recent past, we believe the market is now compensating us for currency diversification.
The five leading contributors to performance in the first quarter were all Japanese stocks: Fanuc, Keyence, Secom, Hoya and Sompo Japan Nipponkoa Holdings, all of which posted strong returns. The gains were driven in part by domestic flows in the Japanese market as local investment funds repositioned money away from bonds and into equities. Many stocks we’ve held in Japan for some time have begun to converge on our sense of their intrinsic value, and we believe the margin of safety is not as apparent as it once was. As a result, we’ve transitioned from being a net buyer in Japan to being a patient net seller.
The five largest detractors from first-quarter performance were National Oilwell Varco, Microsoft, Intel, American Express and Cenovus Energy. National Oilwell Varco, which provides complex equipment to energy exploration and production companies around the globe, and Cenovus Energy, a Canadian firm with oil sands operations in Alberta, both lost ground because the price of oil remained depressed. Despite the underperformance in the first quarter, we added selectively to our positions in National Oilwell Varco and American Express. Although the companies will face tough operating conditions over the next year and a half, we believe they have very strong balance sheets and market positions.
We appreciate your confidence and thank you for your support.
Sincerely,
First Eagle Investment Management, LLC
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