ClucasGray Global Fund

Transcription

1 ClucasGray Global Fund MONTHLY LETTER October 2017 Economic News Economic data across the board continues to reflect synchronised global growth. The US manufacturing PMI retreated from its recent high to 58.7 while the nonmanufacturing index hit a new recent high of These levels continue to suggest that underlying activity is strong. US employment rose by in October and prior months were adjusted up by a net Unemployment fell - 0.1% to 4.1%. As stated last month recent data has been heavily influenced by tropical storms but, when taking an average of the last two months, the economy continues to generate around jobs a month. Wages rose by 2.4% YoY which is weaker than recent months but still supports total earnings growth of over 3%. The European manufacturing PMI rose to another new high of 58.5 and the services PMI fell back to 55. Confidence in Germany and France are high while Spain has been negatively impacted by recent events in Catalonia. The Chinese manufacturing PMI (51.2) strengthened and services PMI (51.6) weakened. Recent actions to moderate excess production in certain sectors as well as to reduce pollution are restraining growth. Strong domestic consumption and exports remain supportive. It is worth noting that we are approaching another US interest rate increase which is expected to be announced by the Fed in December. While the US yield curve has been rising as interest rates have increased, it has recently started to flatten. This is due to longer dated yields falling while short dated yields are flat. This is important as a flatter yield curve is often a sign of weaker growth or a recession. While we are aware of the signal it presents we believe that the long end of the curve is severely distorted due to monetary policy which has led to a lack of paper and that this is therefore more an issue of supply and demand than investors turning negative on growth. We will continue to monitor this as a weaker growth outlook would leave equities looking exposed. Market Comment (all data stated in USD) The US $ and US markets led global markets higher. Strong economic

2 indicators and a rebound from stormrelated weakness boosted sentiment. The US earnings season was off to a solid start with strong results being reported by many of the technology leaders. Not only was the growth strong but it showed an acceleration from already high levels. As was expected, the proposed US tax reforms would reduce the US corporate tax rate from 35% to 20% and potentially impose a 10% repatriation tax on US corporations foreign earnings. This was at the top end of expectations and, if passed, will help to boost sentiment. The All Country World Index rose +1.8% in US $. In the US the S&P was up +2.4% and the Nasdaq +3.2%. In Europe the Eurostoxx (-0.2%), SMI (-2.7%) and the FTSE (-0.4%) fell while the CAC (+1.2%) and DAX (+1.2%) rose. The US $ rose against the EUR (+1.7%), CHF (+3.0%) and GBP (+2.0%). Fund Perspective (Each month we comment on a company or investment theme in the fund) Quarterly Earnings Roundup The Q earnings season reporting is coming to an end. In Europe and the US overall earnings have come in ahead of expectations. Technology has once again been the stand out sector. Energy also produced numbers well ahead of expectations, admittedly off a low base. Elsewhere the picture has been mixed, with a number of disappointments. Technology is clearly disrupting and impairing profits across many sectors of the economy. The pharmaceutical sector continues to find conditions difficult and the improved economic growth has not translated into higher profits at a number of industrial companies. Overall the Fund s investee companies reported strong results but there were a few that did not meet our expectations. Banks The US banking sector delivered another good set of results. Top line growth was held back by much lower fixed income and currency (FICC) revenues due to a lack of market volatility. Bad debts in certain consumer areas also increased from very low levels. Citigroup posted good numbers, they performed better in FICC than most and saw a return to growth across all of their non-us businesses. There was some disappointment over lower than expected profitability in their US credit card business

3 and a modest increase in bad debt within this segment. Citi remains the cheapest large capitalisation US bank on a price to book basis and is the single largest position in the Fund. JP Morgan posted solid numbers despite a much smaller contribution from FICC. The underlying business continues to perform well with the bank taking market share across many segments of banking. With a strong balance sheet the company will continue to benefit from rising interest rates and a stronger US economy. In Europe, BNP reported good results although modestly below expectations. This was as a result of FICC, which was down -23.6%, and low margins in Europe due to negative interest rate policy. Importantly loan growth accelerated across Europe, bad debts are very low and the company continues to hold costs down. The quality of earnings is better and the company is well positioned to benefit once the ECB moves away from current policy. Healthcare Pricing pressure continues to be a problem for the sector. The combination of patent expiries and pressure from governments and health management companies is holding pricing back. Roche produced a disappointing set of results. Competition for some of their key drugs such as Avastin, Tamiflu and Herceptin is a growing issue and, while the company has a strong pipeline, recent test data has been disappointing. Despite the relatively cheap valuation we will need to see progress on the pipeline to justify remaining invested in Roche. Pfizer reported slightly better than expected results. While overall conditions remain challenging due to patent expiries, the outlook is improving as new products ramp up. They also announced that they will either spilt off or sell their consumer healthcare business - either path would realise value for shareholders. Good cost control and share buybacks continue to boost earnings. Abbvie posted strong sales and earnings growth. This continues to be driven by gains from Humira, the world s best-selling drug, and Imbruvica, which is growing rapidly and looks to have significant further potential. Importantly Abbvie announced that they have agreed a US licencing agreement with Amgen on a bio-similar for Humira starting 31 Jan 2022 which effectively removes them as a challenger prior to this date. This is important given Humira represents over 50% of Abbvie s total sales.

4 Sanofi also reported disappointing sales as pricing deteriorated faster in segments of the US diabetes market. This is expected to remain a problem for Take up of some of their newer products has been hampered due to a lack of government budget for core medical needs. The valuation is reasonable but the mediumterm outlook for revenues and profits is subdued. UnitedHealth reported another exceptional set of results. They have strong momentum across their business and are well positioned to benefit from greater levels of employment and changes to how the industry operates. Technology Alphabet (Google) delivered accelerating growth in sales and profits. Momentum in Asia picked up as the company tailors more of its services to regional markets. Core search and YouTube continue to show rapid growth and areas such as Cloud, Playstore, hardware and connected devices offer huge growth potential. Apple reported better sales and earnings. All product segments did better than expected. What was noticeable was the growth achieved across the product range. Having lagged over the last few years ipad, Mac and wearables are showing strong growth. Services revenues continue to grow well and represent a growing stream of high margin sales. Music sales also returned to growth due to the rapid adoption of Apple Music. Facebook posted another exceptional set of results. Strong top line growth is driving a lot of operational leverage. Businesses have shown that they are prepared to pay higher rates for well targeted advertising. Instagram has become a more important contributor to growth and will likely remain so. The company did warn that the outlook for 2018 is more subdued as they will invest heavily in people and systems to help scale growth and address the concerns of fake news and political abuse of their platform. This will come at the expense of profit growth. Priceline reported better than expected revenues and earnings. The company announced that they will significantly increase the level of direct advertising in 2018 to strengthen the brands and to reduce their reliance on internet search engines and 3 rd parties for business sourcing. They will also invest more in people and systems to further expand their reach into the vacation rental market. This is likely to impair profit growth in The fund has been a seller into strength and will be a buyer into any weakness.

5 Alibaba, which is the primary asset held by Altaba, reported a blowout set of results. Rapid growth in Chinese and international consumer sales is driving very high levels of growth. The outlook for 2018 remains robust as the core business expands and they enter new areas such as cloud computing. Consumer Discretionary Daimler reported good operating results that were partly offset by provisions required to resolve emission issues with previously sold diesel engines. The product line up is very strong and Daimler continues to take market share at the top end. They also announced increased capital expenditure to speed up the introduction of hybrid and electric vehicles across their range of cars. They expect productivity gains to help offset a portion of the increased cost base. Michelin reported sales in line with expectations. They are benefitting from higher prices. Overall market conditions remain stable with volumes improving in line with economic growth. The higher margin mining market is enjoying strong volume growth. GKN sales came in below expectations and the company announced that they are facing two small customer claims. The combined result is that profits for the year will be below expectations. The company is well positioned within aerospace and the auto supply sector but has not delivered good shareholder returns. They have announced a change in management and we would like to see the new management realising value for a company that trades at a substantial discount to its peers. Walt Disney and Home Depot have not yet reported. Industrials Union Pacific exceeded expectations. Volumes were mixed, with coal and industrial products performing well and agriculture and auto showing year on year declines. Costs remain well contained and the company expects to improve margins over the next few years. If energy prices remain at or above current levels over the next 12 months this would assist volume growth. Faster economic growth and lower taxation would also provide a major boost to this company. Siemens results came in below expectations due to weakness in power and gas and renewables. The outlook for these businesses remains difficult for The rest of the business performed well and they expect to list their healthcare business in 2018 which should unlock

6 value. The Fund has been a seller into strength and now has a relatively small exposure to the company. We like what management are doing and are likely to be a buyer into any meaningful weakness. Johnson Control Instruments has yet to report. Consumer Staples Anheuser-Busch reported disappointing results. US volumes remain weak and Brazil has yet to recover. Longer term value will be driven by the merger with SAB and the resultant cost savings. The Fund sold its total share position ahead of results and swapped this into equity options at a lower price. Energy Trends across the sector remain consistent. Costs are falling, product prices and margins are improving and this is driving a substantial improvement in profits and cash flow. It is clear listening to management that, despite the strong volume growth our investee companies will achieve, the focus is on reducing the cost per barrel of production. We believe that the market is underestimating the turnaround and remains too negative on the outlook for energy prices. The Fund s overall position in the energy sector has risen due to increased exposure to Devon Energy and Total despite the exposure to BP having been reduced. Of the major oil companies BP has one of the higher cash flow breakeven levels and we believe the others offer cheaper exposure. Summary In most cases earnings were in line or better than expected. A few of the companies have not met expectations and while one cannot put too much emphasis on a single quarter we will review what this means for our investment in these companies. Credit and Fixed Investment / Bonds The Fund currently has zero exposure. Closing Comment The Fund produced further gains over the month but below the market. This is partly a function of the higher cash holding and the hedging within the portfolio. Gains were largely driven by the sizeable technology holdings with Alphabet, Apple and Facebook all performing well. There were a number of minor changes to the portfolio. We remain encouraged by the results achieved in the technology sector and believe the long term valuations

7 do not fully discount the expected growth. Further exposure to Alphabet, Altaba and Facebook was added. Positions were also increased in BNP Paribas, Daimler and Johnson Control. Exposure to Abbvie was further reduced into a rising share price. As mentioned above, the Anheuser-Busch share position was sold and exposure was taken in equity options at a lower price level. Market valuations remain elevated so we have increased the level of hedging within the portfolio. The prior S&P hedge was disposed of and has been replaced with a new larger position that provides 8% downside protection on $10m notional value at an S&P500 index level of 2500 (3% below the current level). This position runs until 15 December Gross and net cash increased over the month. The Fund s US exposure rose to 61.4% of invested funds and, on a net basis, the Fund s total exposure to USD rose to 70.0%. Maximum equity exposure fell to 86.0%, with cash equities at 75.0% and equity options of 11.0%. Net cash holdings rose to 14.0%. Regards, Chris.