Mackenzie Ivy Team
- The fourth quarter was an interesting end to an eventful year in U.S. equity markets. A strong finish after a weak start. Total corporate earnings were roughly flat year over year as local currency growth for global corporations was offset by currency and energy and commodity exposed companies across many different sectors saw earnings deteriorate while domestic companies without commodity exposure experienced steady growth. So the action was in valuation multiple contraction and expansion based on market participant’s views on future growth – which fluctuated between pessimistic at the start of the year to optimistic at the end. Growth appears to be on investor’s minds after promises of less regulation and increased fiscal stimulus from President-Elect Trump. At the same time protectionist rhetoric and generally erratic commentary are tough to reconcile with a pick-up in sustainable productivity and therefore growth. More spending and more debt in an already highly leveraged global economy that is increasingly characterized by political polarization is not what we would consider a benign back-drop.
- European markets ended 2016 on a strong note, following global markets higher starting in early November. Financial stocks, particularly banks, were the strongest contributors to this increase. Less cyclical areas like Consumer Staples and Healthcare were the worst-performing sectors, actually declining while the market rallied.
- Q4 performance in Far East markets, similar to other global markets, was driven largely by the following sectors / stocks: 1) financials, 2) commodity and other cyclical stocks, 3) individual stocks that benefit from a stronger US dollar (and weaker local currency). At the same time, there was a rotation away from more ‘defensive’ stocks, as well as companies whose earnings may be negatively impacted by a stronger US dollar. In terms of currencies, the Japanese yen, Korean won, and Australian dollar all depreciated significantly relative to the USD during Q4 – this led to a dampening of USD-denominated returns for all these major equity indices.
- Seven & I Holdings was a detractor to performance due largely to weaker Japanese yen relative to the US dollar, and also due to share price decline. The share price fell in the quarter due to normalizing sentiment (which turned overly positive towards the end of Q3), and also due to market rotation into more cyclical and currency-sensitive stocks which benefit from a weaker Japanese yen.
- In Q4, we significantly increased position in Hennes & Mauritz (H&M), which has been a small holding for Ivy European for a decade and was a previous holding for Ivy Foreign Equity. H&M designs and retails clothing under its own brands, and has shown its ability to succeed in many different countries (unusual for a clothing brand). The past few years have been difficult, as a combination of heavy internal investment and weak markets have led to lower profitability. Our view is that this relatively weak period is temporary rather than structural, and we believe the strengths and culture that have driven H&M’s long-term success are still intact. We saw the share price as attractive from a long-term perspective.
- We reduced the position in Samsonite International modestly as the Company has just recently completed the TUMI acquisition, and has significant debt on the balance sheet; while we believe the Company will make progress on the integration and debt repayment, we have elected to take a slightly more conservative position as we wait for confirmation of this.
- We reduced our exposure to Danone, which was an effort to manage business risk more so than valuation risk. Danone announced a large acquisition (branded food company WhiteWave) that will lead to integration risk and will stretch its balance sheet. We consider the business risk associated with Danone to have increased, so we have reduced our exposure accordingly.
- We exited our position in 3M due to valuation and some concerns around long-term financial strategy.
Outlook & Strategy
What are the key opportunities you see?
- We tend to see opportunities on a stock-by-stock basis, where the price of a high-quality company’s stock is low relative to our view of the company’s long-term prospects. During the quarter, we significantly increased our position in Hennes & Mauritz (H&M). We also added to our positions in Aggreko, Sonova, Henkel, and Nokian Renkaat, as the valuations of each stock became more attractive.
- More recently, we have seen opportunities arise in the Hong Kong market. This has been one of the weakest performing Far East markets following the US Presidential election. Specifically, we have seen weakness in the consumer discretionary sector, and also with select stocks that sell products in the US but manufacture in China and other parts of Asia (due to concern about the impact of protectionist trade policies). As a result, we have modestly increased positions in some of our Hong Kong-listed holdings.
What are key risks that need to be managed?
- We have outlined our concerns about broad market valuations for several quarters now. Until recently, the primary supporting factor for valuations had been ultra loose monetary policy globally. Valuations have become even more expensive following the results of the US Presidential election. Now, equity prices have been pushed up by another supporting factor – the prospects for improved global growth, as a result of expansionary policies in the US. We remain skeptical about the benefits of both of these aforementioned factors. Therefore, we believe two of the most significant risks to equity markets in the medium term are 1) normalizing interest rates and the impact on broad market valuations, and 2) reduced optimism about global growth prospects.
- The stocks we hold present their own risks, from a business perspective as well as a valuation perspective, and we manage these risks through our weightings in the Fund. For example, we reduced our positions in TGS Nopec, Rotork, and Richemont. All three stocks went up considerably in the past six to nine months, which had two impacts: their weightings within the Fund went up, while our “expected return” (valuation) for each stock declined. This introduces more valuation risk into the portfolio, and our discipline led us to reduce our exposure to these stocks to manage this risk.
How are you positioning portfolios in response to this outlook?
- United States: Expected returns in the portfolio have flattened out as a result whereas before Trump’s election we saw greater expected returns in the more sensitive names which were our largest positions. We added to Nike, Oracle, US Bancorp (pre-Trump), W.W.Grainger (pre-Trump) and Henry Schein during the quarter while reducing positions in Colgate, Pepsi and Proctor & Gamble (all pre-Trump), US Bancorp (post-Trump), Omnicom (post-Trump) and UPS (post-Trump).
- Europe: Overall, valuations continue to be unappealing, so cash remains quite high (though down slightly during the quarter). We remain slightly underweight Consumer Staples, a sector where the Fund has traditionally had a large exposure. There are plenty of high quality companies in this area, but they have become increasingly expensive in recent years. Finally, we continue to have no exposure to European banks, which compose a material proportion of the overall market.
- Far East: While we agree that a move to more normalized monetary policy is a good thing, we are also somewhat skeptical about Mr. Trump’s ability to revive global growth by increasing fiscal spending, cutting taxes, and still managing to maintain a reasonable US government fiscal position. We also believe many of the protectionist trade policies that have been discussed could have significant adverse second order effects. We have also not changed our long-term growth forecasts for our holdings. As a result, our cash weightings remain rather high.