Mackenzie Cundill Team
- The value cycle has been trading at trough valuations against growth and is showing resurgent signs of a recovery that began last spring 2016 but was interrupted this spring 2017 on fears that the Republican administration would not be able to deliver on stimulative reforms such as tax reform, infrastructure spending and deregulation. With the passage of the US federal budget in September, investors are warming up to the possibility of tax reform that could substantively help the bank’s earnings as they have a lot of domestic revenue. However, barring tax reform, the banks are still very cheap at 1.0x Book Value on historic measures and have seen these valuations peak at 2-3x book value in past cycles. The global economy is indeed accelerating, and there are strong signals from major world central banks toward a global tightening bias where interest rates are going higher. Both great for banks.
- We see concrete evidence that the underlying global economy is strengthening and that is what ultimately drives returns rather than geo-political uncertainties which tend to hold the market's attention in the short run. Despite concerns from various pundits that the market is expensive, we find undervalued stocks in a number of segments of the market, such as financials, energy, healthcare and media. The portfolio is fully invested as we have high conviction that the securities we hold offer significant upside.
Outlook & Strategy
- There are many positives in the current global environment. The US economy is healthy and labour conditions are beginning to look tight. Consumer confidence in the US is at highest levels since 2000. There are emerging signs of corporate investment in terms of capital goods. Industrial production recovery is prominent in most developed countries. The cycle is younger in Europe but recovery is broadening and is led by the consumer. Unemployment in Europe is back down to single digit and wage growth is on an upward trend as well. The Euro-area is on track to deliver the strongest expansion in a decade, amidst the highest business and consumer confidence since the global financial crisis. Euro-area manufacturing PMI is at the highest level in 6.5 years. The new French government is starting to deliver on labour reform. Tax reform is being discussed in both the US and France, which will be stimulative when policies are enacted and adopted. Despite concerns of Brexit, UK manufacturing growth remains solid, although the consumer is showing signs of hesitancy. We remain watchful over Brexit negotiations and believe that a transition period will likely provide businesses a level of certainty to plan their strategies. European banks' balance sheets are strengthening and credit cost are coming down. Global trade volume has improved from mid-2016 to a current mid-single digit percentage growth pace.
- In China, tighter credit conditions in the first half have cooled down the property sector. But so far consumer sentiment and spending is holding up and measures such as electricity output and copper prices point to largely steady growth. Business conditions are at the strongest level in a decade in Japan. Japanese GDP has been positive for six straight quarters, which is a rare occurrence in recent memory.
- Despite global synchronized growth, the lack of headline inflation is puzzling many economists. We believe that corporate investments, industrial production gains and wage pressures are leading the direction of inflation. Inflation has not disappeared but is merely delayed from hitting headlines due to the gradual nature of this cycle.
- This environment is not one without risks, however, as there appears to be plenty to worry about in a world of political uncertainty. Such "headline" risks include Trump's administration's ability to deliver actual policies, Catalonia's desire to separate from Spain, upcoming Japanese and Italian elections, North Korea's nuclear ambitions and Kim's war of words with Trump. However, we believe the strength of the real economy and earnings growth are what will drive equity valuations in the long run. And we continue to focus on finding stocks that are trading at prices below their intrinsic value. The portfolio remains fully invested as we see no shortage of ideas. We remain enthusiastic about the opportunities we find in the market and believe our portfolio has plenty of upside.
- In summary, the global macro backdrop remains supportive of corporate earnings growth. Equity valuations, while expensive across some sectors and styles, remain cheap on an absolute and relative basis across a wide swath of value oriented sectors/stocks. Cundill continues to be overweight Financials, Energy, Healthcare, and Industrials; underweight Tech, Telco, Utilities, and Staples. US Financials should benefit from increased capital returns, deregulation, and expanding net interest margins; Energy on the continued balancing oil markets; and Healthcare and Industrials on a confluence of tax, cyclical tailwinds and a weaker USD. International growth remains solid with both EM and the Eurozone (despite the stronger EUR) expected to deliver solid earnings growth.