Mackenzie Cundill Team
- The global economy continues to accelerate 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. The global financial system is strengthening. We believe we will see global central banks continue on a path of interest rate normalization. Monetary stimulus will play less of a role going forward. There will be more discussions about fiscal stimulus.
- Our investment thesis in the US banks has been reaffirmed by the Federal Reserve CCAR (Comprehensive Capital Analysis and Review) results in June. All of our holdings passed this year’s test with flying colours, both quantitatively and qualitatively. Citigroup announced it will double its dividend and approved a massive share buyback program of $15.6 billion. In our recent meeting with Citigroup’s CFO, we sensed that the fundamentals of its businesses are improving. In addition, economies around the world are accelerating.
- Bank of America increased its dividend by 60 percent while authorizing $12 billion in stock repurchases. Warren Buffett announced that Berkshire Hathaway will switch out of the preferred shares they own and exercise their option to buy 700 mil shares of Bank of America, becoming the top holder of the stock. While we get diluted some, Buffet’s willingness to assume greater risk for a (marginally) higher payout on the common is a testament to his confidence in the earnings power of Bank of America.
- Wells Fargo’s capital plan was also approved by the Fed, which included up to $11.5 billion of common stock repurchases. This is especially good news in light of recent negative press regarding sales practices at this bank. We believe Wells Fargo is a solid franchise and the current issues are short term in nature and very fixable.
- Key reasons we like the above US banks are: improved earnings outlook, very low valuation, solid capital positions, and increased payouts to shareholders. If there are any positive developments in tax reform, industry deregulation, or more interest rate hikes in the US, we believe the banks will stand to benefit further.
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 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.
- We are witnessing an environment of synchronized growth around the world. Despite a typically weaker Q1 in the US, data is pointing to accelerated growth into the second half. Economic activities in Europe continue to improve and is surprising to the upside for the European Central Bank and the investment community. Now that the French election is behind us and was won overwhelmingly by Emmanuel Macron and his party En Marche, the risk of dissolution in the Eurozone has substantially disappeared. There are in fact encouraging signs that the new French government will be more business friendly than in the recent past. The ruling party’s majority position may give them the political capital to tackle economic reforms. The path to seeing reforms in France will likely still be long and bumpy, but nonetheless it should be heading in the right direction. In the aftermath of the Macron victory, Eurozone valuations rose sharply versus the rest of the World, however have moderated since, falling back to the middle of their historical (relative) range.
- The loss of a majority government by Theresa May in the UK election appears to be negative on the surface. However, a weakened position for her may in fact mean that her “hard Brexit” stance will now be diluted, which could be quite positive for businesses. In addition, an improving economic picture in Europe is a positive for the UK and the subsequent negotiations, as rational discussions are more likely. We continue to believe that Brexit negotiations will focus on maintaining important trade relations, as both sides understand the importance of their economic connectedness to each other.
- The Fed in the US hiked rates during the quarter and expanded discussions on how to manage down the size of its balance sheet. We believe normalizing monetary policy reflects the improving fundamentals of the economy. Even in the Eurozone, ECB President Mario Draghi will likely start to shift central bank policies toward a tapering or reduction of quantitative easing later this year and into next year. Increases in long dated government bond yields in the US and Europe reflect better economic growth and some mild reflation at the moment.
- The rescue of Banco Popular by Santander in Spain, and the absorption of two regional banks in Italy by Intesa Sanpaolo with state support, are further signs that the financial conditions in Europe continue to heal. Investor confidence in the banking sector improved after these deals were announced.
- Business confidence in the manufacturing sector in both Japan and Germany has reached 6 year highs. Manufactured exports from these two countries tend to be consumed by demand in America and China. Orders in manufacturing and services are rising. Interest rates on both sides of the Atlantic will likely continue to “normalize”. Of particular note is the narrowing interest rate differential between the US and the rest of the world, which could pressure the USD and drive liquidity into EMs.
- Trade in Asia appears to be picking up, lifting exports of Korea and China. Despite some monetary tightening in China recently, the economy on balance is doing well as the shift to domestic services and consumption continues. Excess capacity in industries such as steel has started to come down gradually. One regional risk we are monitoring closely is the political and military developments in North Korea. Our portfolio’s exposure to Japan, China and Korea together is not excessive given the mandate.
- In conclusion, we believe we will see more evidence of accelerated economic growth in the large developed economies of the world in the second half of this year. Central banks in those regions will likely start to or further normalize interest rates. Related financial institutions should be the biggest beneficiary of tapering, hence our portfolio positioning should prove opportunistic. Value equities in general, however, are trading at lower valuations than the overall market and are poised to outperform.