Mackenzie Cundill Team
- The global economy continues to improve and we see fundamental macro improvements in all the major regions. The re-emergence of inflation is also taking place. That is an environment where value stocks could extend their gains. However, currently the market is concerned with a number of headline risks, causing profit-taking in the winners of 2016 and fund flows back into the bond market in the near term.
- The Trump administration’s failure to pass their first bill in health care is being showcased as evidence that the government may not be able to get much else done. We have held the view that to replace Obamacare would not be that simple, but there are other items on the Republican agenda that are more likely to gain wider support. Tax reform of some kind, reduction in regulatory burdens, and infrastructure spending are areas that a significant portion of the administration can agree on and we believe some policy action is likely before the mid-term elections in November 2018. However, the U.S. economy is improving and any additional fiscal stimulus could very well be “fuel on the fire”.
- Our Financials holdings pulled back as interest rates decreased over the quarter. AIG and Citigroup were detractors. We met with Citigroup in March to discuss their path to meeting the group's target 10-14% ROTE (return on tangible equity), the current interest rate environment, regulatory reform in the U.S., and capital return to shareholders. We came away with continued conviction with our investment in Citigroup.
- Canadian lumber-related stocks, including Canfor and West Fraser, have experienced strong recent performance on higher lumber pricing. Worries about the impact of potentially punitive duties and tariffs on Canadian lumber have led to higher lumber pricing. This is happening during a seasonally strong period of lumber demand as the construction cycle kicks in south of the border. The issue facing Canadian producers is whether pricing will rise enough to compensate for trade-related charges, enabling them to sustain margins. One difference between the current round of trade negotiations and the prior one a decade ago is that the Canadian industry has developed key offshore markets, particularly in China. This should serve as a potential outlet for lumber if margin differentials are supportive.
Outlook & Strategy
- We are confident that we are in the early stages of a long-run, multi-year resurgence of value investing, which typically lasts 5 to 7 years based on historical analysis. Since 2009, the markets have rewarded growth stocks during the period of muted economic growth, and bond proxies as conservative investors searched for safety and yield. While we expect to see months and quarters where these types of names will outperform value-oriented stocks, we believe that the tide has turned and the current backdrop is very constructive for value investors. This is evidenced by our ongoing ability to find excellent value in areas such as U.S. financials, cyclicals, healthcare, and enterprise technology. Markets began to recognize the value in these investments last year and we believe there is still a lot of upside potential in these opportunities.
- In Europe, all eyes are on the French election. The populist candidate Marine Le Pen is still one of the front runners and markets are concerned with a potential “Frexit”. We believe the risk of such an event is low as most French citizens want to stay in the Eurozone. Having said that, we need to monitor such risks. We do have exposures to France and the Eurozone in the portfolio. As a result, we have taken a partial hedge on our Euro exposure to mitigate potential risks. Apart from the French election, Brexit negotiations will be widely followed. We believe such negotiations could take longer time than most political watchers expect. A near term dramatic break-up is not likely as that is not beneficial to either side. We believe that once the German election is over in the latter part of this year, serious negotiations could take place and rational minds and cool heads should prevail at the end of the day.
- Despite the political uncertainty, European consumer confidence, economic activity and inflation are all heading in a positive direction.
- In Japan, the economy is stable but wages are not really growing and the inflation rate, although positive, is still far from the central bank’s target. What further structural change could come from Abenomics remains to be seen.
- In China, consumers seem to be in decent shape. Demand for imports have increased 15% year-over-year. However, the high level of debt in the financial system is a concern though most debt is held domestically. The government is starting to tighten monetary conditions to discourage further growth in debt.
- Overall, we believe that we continue to have a portfolio with significant value and meaningful upside. Valuation of the portfolio in terms of price-to-book as well as price-to-earnings is much more attractive than the broad market. We believe we are in an environment of synchronized growth around the world, which should bold well for value stocks.