First Eagle Global Value On A Gloomy Macro PictureVW Staff
First Eagle Global Value Team annual letter for 2014.
The First Eagle Global Value Team has structured what we believe to be an all-weather portfolio for our investors. With 2014 being a strong market for risk assets, it hasn’t been the optimal relative performance period for the portfolio. We ended the year with sound absolute returns in most currencies but we were below our real return goals in the United States due to the strength of the U.S. dollar. The weak spots in our bottomup performance were concentrated in the companies that own harder assets such as precious metals miners or energy extraction companies. Generally, the harder the assets, the softer the balance sheets and/or the free cash flow, and thus the weaker the stock price performance in the portfolio. This price action is entirely consistent with the flattening of the yield curves that we saw around the world for the sovereign markets and the widening of high yield credit spreads which implies lower global growth expectations. Also, consistent with this was the dramatic weakness in commodities; not just in energy, but also in agriculture commodities, in iron ore (which lost more than half of its value based on spot price over the last couple of years) and more recently in copper. While commodities have continued to be weak early into 2015, gold has decoupled and acted more like a monetary reserve than a regular commodity in the wake of the Swiss Franc de-pegging with the Euro and the initiation of European quantitative easing measures.
You may have heard us refer to Bill White in the past and we continue to focus on his work. Bill White is the former head of the Monetary and Economic Department of the Bank for International Settlements who predicted the credit crisis before it unfolded in 2007. The Bank for International Settlements, given its legacy as the central banks’ central bank, has often cast a more cautious eye on the global financial architecture than say the IMF or Wall Street consensus. Bill White is now the current chair of the Economic Development and Review Committee at the OECD in Paris. Speaking at a conference in New York towards the end of last year, he posed a very interesting rhetorical question which we’d like to paraphrase. In reference to the global economy he asked, “What if there is no equilibrium, what if the world economy is much more like a forest, which is like a complex system that’s path dependent?” Path dependent complexity means that the system plays out in ways that are difficult to predict based on what you do to it. He went on further to ask, “What if we’re actually on a bad path, a bad path caused by too much debt, exacerbated by the disinflationary pulse of too much labor?” These observations resonate with the themes we have discussed at length in the past.
First Eagle Global Value on too much debt
On the subject of too much debt, we’ve repeatedly made the point in the last several months that globally, we have more debt relative to the economy today than we had before 2008.1 In essence, the deleveraging in the U.S. private sector debt has been more than offset by the growth in Chinese debt. Furthermore, within the developed markets, debt has also grown relative to output due to large growth in government sector debt and in certain high yield issuers. Regarding the disinflationary pulse from too much labor, we’ve spoken at length about factory automation taking away manufacturing jobs. This presents a structural headwind to employment in the world and a structural challenge for the emerging markets like China which has moved many people into manufacturing jobs.
A recent TED talk on the subject of technology with guest Jeremy Howard,2 who heads an artificial intelligence (A.I.) company called Kaggle, was quite illuminating and disturbing. He not only reinforced the message about technology substituting for human capital on the factory floor, but he took the point further to show how computers are within a handful of years of substituting for humans within the services industries as well. The capabilities of A.I. programmed computers could cover many of the jobs in lower-end services. He also mentions that during the Industrial Revolution, machines were created that were more efficient than humans, but the growth curve gradually plateaued as the level of capital grew relative to the economy. Now, Howard describes a phenomenon that becomes self-reinforcing in which the nature of artificial intelligence feeds on itself. So what starts to happen in the services sector in the next handful of years will be a trend in the next decade and beyond that accelerates in nature because machines will learn from their learning. Long term, it was beneficial to move people out of low-end agricultural jobs into manufacturing and services. Likewise, it should be positive long-term for productivity to employ less people in manufacturing and services jobs in order to free their time for higher and better use; but these trends can be quite disruptive for the impacted generation.
The forces of too much debt coupled with IT substitution for human capital are going to be with us for a long time, exacerbated because debt levels are generationally high and the forces of disruptive IT-related change are accelerating. Add to that the geopolitical developments in the Eurasian continent—Russia, China and the Middle East—which are moving away from the American and European policy agendas.
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