Mackenzie Ivy Team
- The U.S. market was led by segments of the Technology space and the Materials sector, as concerns over valuations have abated in Technology and the direction of change in commodity markets turned positive. We had little exposure to either of these quarterly market tailwinds, and so the U.S. holdings underperformed.
- We see the U.S. market as broadly overvalued, with share price levels and growth expectations appearing excessive. Revenues are growing on a local market basis for most U.S. companies and the U.S. dollar headwind appears to be abating. More deeply cyclical names in the industrial space that have rebounded this year are still experiencing organic revenue declines but margins have held well due to heavy cost cutting. This has a finite limit and if organic revenue growth doesn’t rebound to the level assumed in share prices, it will be difficult for share prices to stay where they are.
- European markets were quite strong in the quarter, and Ivy’s European holdings generally lagged. One reason for this underperformance was Aggreko, UK-based global leader in the provision of mobile and modular power. Aggreko’s business tends to be lumpy as it often involves significant contracts. In their first-half earnings report, the company flagged some concerns about the prospects for renewal of their contracts in Argentina, which are quite profitable, and this contributed to the weak share price performance. On the plus side, order intake at the company has been quite strong this year, and Aggreko has made strides in new technology development, so we believe the long-term prospects for the business remain intact.
- Publicis Groupe and TGS Nopec Geophysical were among the biggest positive contributors in the quarter. TGS is a Norwegian business active in seismic imaging, essentially mapping parts of the ocean floor and licensing the data to oil and gas companies, who use it for exploration and production purposes. The seismic industry is quite cyclical, but TGS has weathered past cycles by virtue of their business model and culture: they are asset light (unlike peers, they contract seismic vessels rather than owning them), they have no debt, and they have a counter-cyclical mentality that leads them to invest heavily during downturns to acquire data cheaply. The current downturn has been difficult for TGS, but they continue to execute their strategy while some peers have gone bankrupt or are otherwise constrained by high debt loads or steep losses. TGS’ stock price performed well during the quarter as signs emerged that suggested that demand for seismic data was no longer getting worse.
- From a sector perspective, European banks had a relatively strong quarter. The Ivy funds do not hold any European banks, so this hurt relative performance. On the positive side, Ivy does not currently hold any European pharmaceutical stocks, and these did relatively poorly in the period.
- We reduced our holdings in Danone, due to a combination of a rich valuation and a heightened level of risk following the announcement of its upcoming acquisition of WhiteWave. While WhiteWave’s portfolio of branded organic dairy and dairy alternatives is a good fit for Danone’s business, the price was rich and we believe it will stretch the company’s balance sheet. For these reasons, a lower weight seemed appropriate.
Outlook & Strategy
What are the key opportunities you see?
- In the U.S. we are looking at a select number of opportunities that may presently turn into portfolio holdings. The opportunity set is quite small and is characterized by one-off opportunities.
- We continue to believe that valuations remain stretched in Europe. There have been a few company-specific opportunities to add to a few positions, mostly among more cyclical businesses, while defensive names remain almost uniformly expensive.
What are key risks that need to be managed?
- As has been the case for a while now, we consider the most significant risk to the portfolio to be valuation. We consider the broader market to be expensive, which demands patience, although there have been a few select opportunities that we have taken advantage of, as noted above. We also consider how idiosyncratic event risks will impact a business. We are not macroeconomic forecasters, but we strive to understand how a business and management team will behave in any market environment. We continue to manage these risks by following our process, including a deep understanding of the companies we own and adherence to our valuation methodology.
How are you positioning portfolios in response to this outlook?
- United States: We remain underweight in our U.S. equities as a result of our view on valuations. We do see some variation between our highly regarded names like Colgate, Pepsi, and Procter & Gamble compared to names like Grainger, Oracle, and even now Nike, where the stable defensive companies have lower expected returns even on a risk-adjusted basis and the holdings continue to tilt into more cyclical names.
- Europe: Currently, we believe prices in Europe are generally unattractive, which has led to elevated cash levels across our equity portfolios..