Although the World Bank cut its forecast for global growth early in the quarter
from the .... addition to a power tools company in Hong Kong performed strongly ...
From the EGA Portfolio Management Team
Market Overview Equity markets began the new year on a strong note due to an improving U.S. economy and hopes that the new era of Abenomics would bring much needed reflation in Japan. The MSCI EAFE Index rose 5.15% for the quarter, trailing the return of the S&P 500 of 10.61% - which was mainly due to strong U.S. Dollar movement during the quarter.
The Global Economy Global Summary The major economic centers of the world are seeing somewhat diverging conditions with the U.S. holding its own while economic conditions in the Eurozone remain constrained. China’s growth outlook was capped from additional monetary tightening measures, and although Japan’s markets project greater things ahead, near-term economic conditions in the country remain somewhat subdued. However, Japan may see acceleration from monetary easing. The U.S. housing market continues to perform well and the most recent data suggests consumers may have turned the corner and are no longer deleveraging as consumer credit growth has picked up once again. Yet, some economists worry that that fiscal drag caused by the automatic sequester cuts in the U.S. will lead to softer economic growth in the near-term. There is likely to be significant debate in the coming year as to the timing of the Federal Reserve’s withdrawal of the QE punch bowl while some speculate QE bond purchases may end in 2014. Although the World Bank cut its forecast for global growth early in the quarter from the June 2012 forecast of 3.0% to the new forecast of 2.4%, recent economic activity appears to have stabilized and have begun to accelerate in some areas of the world. Boosted by the potential for new measures, Japan’s economy may see a pickup in the near-term while U.S. growth may continue to moderate given the fiscal drag in the country. The Eurozone continues to struggle from continued deleveraging in the area while unemployment levels remain at record highs. Recovery in the euro area is likely to take longer than expected and most expect negative growth for the Eurozone in 2013 with the periphery continuing to show weak results combined with slowing activity in France. The U.K. has surprised on the downside as economic activity there has slowed and inflation remains above targeted levels. Eagle Global Advisors, LLC
Global trade has yet to resume its trend growth due to a weak Europe while worries over potential tightening measures in China led to softening commodity prices during the quarter. The U.S. Dollar strengthened during the quarter mainly due to a weak Japanese Yen. The yen continued to sell off as market expectations for aggressive monetary loosening pressured the currency.
Japan / Asia If Abenomics was the name of a new dance, then the markets surely danced the night away to this new tune. Expectations for new Prime Minister Shinzo Abe’s economic policies and his new Bank of Japan head Haruhiko Kuroda’s first meeting in early April led to strong market reactions in Japan. Even though expectations were high going into the BoJ announcement, it appears the new aggressive policy of targeting 2.0% inflation within two years and the doubling of the monetary base through purchases of government bonds surprised positively, cheered markets and led to continued depreciation in the yen. In addition, Japan has gone a step further by announcing additional asset purchases of equity ETFs and real estate assets to help prop up asset prices in the country. Although the latest BoJ Tankan survey of large manufacturers improved somewhat in March, the latest reading remains quite subdued. Our expectation is that if the yen stays weak for the foreseeable future, Japan is likely to experience higher investment from major corporations as exportoriented manufacturers are better able to compete, hence translating to a nice tailwind for the Japanese economy in 2013.
5847 San Felipe, Suite 930 Houston, TX 77057
713-952-3550
www.eagleglobal.com
Q1 2013
EGA International Equity ADR
Q1 2012
Market Review and Outlook
Q1 2013
Europe
Emerging Markets
With the 17-nation euro bloc still in recession, record high unemployment, and inflation below the central bank’s target, most market participants remain puzzled as to the inaction of the European Central Bank (ECB) in recent months. Eurozone purchasing manager’s index (PMI) deteriorated in March falling to its lowest levels in three months as German PMI fell back and France joined Italy and Spain with weak manufacturing conditions. Yet, given the significant deleveraging that has occurred in the Eurozone and weak demand, it is notable to see that both Spain and Italy have now crossed into current account surplus territory given their poor internal demand. But in Spain, unemployment at over 25% and youth unemployment at over 50%, coupled with soft activity in the euro bloc continues to place significant pressure on economic activity for the Eurozone with economists projecting the region to show negative GDP growth in 2013 while only resuming growth in 2014.
Tightening measures in China and lackluster global trade data poured cold water on emerging market equities during the quarter. The Chinese government’s additional measures aimed at slowing housing price growth as well as controlling the rise in bank’s asset management and trust products led to concerns over economic growth in the country. Although the latest PMI figures for China suggest moderate growth, the economic momentum remains fragile. Global trade has been slow in recovering mostly due to lackluster demand from Europe. Although U.S. economic activity has proved the most resilient, this has not led to significant import growth of EM-manufactured products which tend to be more consumer-oriented. Venezuela devalued its currency during the quarter, while the Philippines received its first-ever investment grade rating from Fitch. Brazil continued to sputter along at sub-par growth while Russia’s links to Cyprus appear the most worrying given the country’s use as a tax haven and financial transaction conduit. Emerging market growth remains a leading edge in the world today and we expect global trade to improve into the second half and 2014, providing support for EM growth.
Private sector credit growth appears to have rolled over in the Eurozone and even in Germany the prospect of negative credit growth is apparent. Germany’s IFO and France’s Insee business climate indicators both fell in March although the most recent German ZEW measuring economic expectations in the country hit a 3-year high, appearing to suggest expected improvement in the German economy in the first half of 2013 after contraction in the last quarter of 2012. The Cypriot bailout appeared to suggest a new bailout mechanism in the Eurozone – shifting more of the cost to bank depositors. This spooked the markets and is definitely worth monitoring to analyze whether it was a oneoff mechanism or a new model going forward. With major German elections upcoming in September, German Chancellor Angela Merkel likely has little appetite for any further actions where any burden is placed on German taxpayers in the near-term. Cyprus was the latest bailout casualty as the EU and the IMF forced drastic measures including forcing depositors to share a significant portion of the bailout terms. Although banks in Cyprus have re-opened, very strict capital controls have kept a lid on any run on the banks in the near-term. We are confident that this is not the last time we will be writing about Cyprus this year.
Politics Italy’s elections came and went with no clear winner and as of this writing the country has still not been able to choose a new prime minister to lead it through these rough times. President Napolitano has appointed two committees to try and negotiate a grand coalition government. If one cannot be formed then new elections will have to take place in June. Mexico’s new President Enrique Pena Nieto was busy during the quarter with bold moves aimed at executing on his campaign promises of reforms and weeding out corruption. The arrest of the powerful teacher’s union boss on charges of embezzlement is a good first step against corruption, while news of a new law aimed at trying to break up the country’s monopoly in telecoms and TV has led to significant hope that the new president is serious about fixing Mexico’s structural problems. The leftist Bolivarian revolution in Latin America was dealt a blow as Venezuelan leader Hugo Chavez died after a long battle with cancer. His VP, Nicolas Maduro, is the frontrunner to win national elections in April. While it is certain that a power struggle may unfold, at the very least we expect a much more watered-down leftist campaign.
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Outperformers
With the country hurting from massive under-investment, food shortages, rampant inflation, and a black market currency that still sees massive devaluation risk, Venezuelans are sure to have a shorter leash on the new president. Turkey’s acceptance of an Israel apology for the deadly raid on a Turkish flotilla in 2012 and possible peace negotiations with the Kurds could make Turkey a stronger and more appealing investment destination.
Although the Eagle ADR portfolios struggled to keep up with the MSCI EAFE Index performance for the quarter there were several bright spots during this period. From a country perspective the bright spots were good stock selection in Hong Kong from existing positions, new additions to the portfolio that performed well and an underweight to Italy and Spain. In addition, the portfolio’s overweight to Switzerland proved additive as the Swiss market performed ahead of the index for the quarter. From a sector perspective, good stock selection in Telecom Services was beneficial in addition to an underweight in the Utilities sector and an overweight to Consumer Staples. Individual bright spots included good selection in transportation as the portfolio’s holding in a Canadian rail company benefitted from improving trends, and a Latin American airline stock performed strongly because of continued competitive advantages benefitting results. The portfolio’s new addition to a power tools company in Hong Kong performed strongly following the company’s significant exposure to the rising U.S. housing market demand for power tools.
Stock and Portfolio Highlights The tail risk that we all seemed to forget about reared its ugly head toward quarter-end as the announced Cyprus bailout, or bail-in depending on how you want to look at it, became front and center on investor’s minds and risk assets reacted negatively. Yet, even with the mess in the Eurozone surrounding Cyprus, the economic slowdown in France and continued drag from the euro periphery, a lack of a government in Italy, and concerns over restrictive policies in China, the markets still managed to perform well for the quarter. The Japanese market was definitely a standout during the quarter as continued hope for Abenomics and new Bank of Japan head Haruhiko Kuroda placed a strong bid on the Japanese equity market, which managed double-digit returns in U.S. Dollars despite the continued sharp devaluation of the yen versus the U.S. Dollar. The dollar index appreciated during the quarter mostly because of the Japanese Yen and the British Pound. While the yen move was mostly geared toward hopes of aggressive monetary stimulus and bond buying, the move in the British Pound was largely due to weak economic data and continued high inflation expectations in the U.K. The Euro periphery struggled during the quarter as the Cypriot bailout reminded investors of the fragility of the Eurozone and the potential game-changing new bailout formula used by the European Union in asking Cyprus depositors to share in the pain of bank bailouts. Growth outperformed value for the first three months of the year and the market favored small and mid caps over large caps during this period. The best performing MSCI EAFE markets for the quarter were Greece, Ireland, and Japan while the worst performing MSCI EAFE countries for the quarter were Italy, Spain, and Austria. In the emerging markets, the best for the quarter were the Philippines, Indonesia and Thailand while the worst for the quarter in the emerging markets were the Czech Republic, Poland, and Egypt.
Q2 2013 2012 Q1
Politics (continued)
Disappointments Stock selection proved disappointing during the quarter as seven of the ten sectors experienced poor stock selection. On the aggregate, the quarter can be summarized as one where an underweight to Japan and poor stock selection in Germany more than account for the underperformance in the quarter. As far as Japan goes, the market’s renewed optimism for aggressive monetary expansion translated to strong gains for this underweight market. Regarding Germany, poor stock selection was due to three of the portfolio’s German holdings that were in the top five worst attributors for the quarter. These included a major chemicals company that fell on the back of weaker materials markets, a major automaker on potential headwinds with year-over-year comps, concerns in the Chinese market and lastly, a major German bank that fell in sympathy with euro markets during the Cyprus fears following investor’s worries over capitalization, regulatory and legal headwinds. Other notable negative attributors for the quarter included stock selection in Financials and Health Care.
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Sales / Trims in the Quarter
BNP Paribas ADR (BNPQY): SECTOR: Financials; COUNTRY: France: This leading French bank is well positioned to navigate through regulation changes as the bank has a strong Basel III capital ratio together with a cost savings program leading to significant upside in dividends while trading well below book value.
British American Tobacco (BTI): SECTOR: Consumer Staples; COUNTRY: U.K.: We trimmed BAT primarily on the back of a premium valuation compared to its 10-year average in addition to slowing earnings growth. Risk has also increased for the industry from a plain packaging movement and the threat of e-cigarettes taking market share.
China Construction Bank (CICHY): SECTOR: Emerging Markets; COUNTRY: China: The large deposit base of CCB allows the bank to benefit from low funding costs. The bank has a strong balance sheet and capital ratios and will benefit from a macro recovery in China. A low valuation and high ROE together with a high dividend yield attracted us to CCB. Deutsche Bank (DB): SECTOR: Financials; COUNTRY: Germany: We added to our position in DB as the bank is benefitting from the leading position of the German economy in Europe and may benefit from deposit flight into safe-haven Germany. Given the bank’s investment bank exposure, it is well positioned for a pickup in M&A activity. Magna International (MGA): SECTOR: Consumer Discretionary; COUNTRY: Canada: This leading Canadian auto parts supplier is well exposed to rising trends in the U.S. auto market. The fuel efficiency movement also provides additional market share opportunity for Magna’s key products. Techtronic Industries (TTNDY): SECTOR: Consumer Discretionary; COUNTRY: Hong Kong: Product innovation is leading this Hong-Kong based power tools leader to gain market share and improve margins. The better cash flow is also allowing for debt pay down. An improving housing recovery in the U.S. is a boost to growth as the U.S. is the company’s largest market.
Q1 2013
Purchases / Additions in the Quarter
BT Group PLC (BT): SECTOR: Telecom Services; COUNTRY: U.K.: BT continues to generate positive surprises but the stock’s significant outperformance versus the sector and the U.K. in the last two years is likely to slow as expectations have increased for results. The group’s significant move into TV and purchase of wireless spectrum add risk to the story as capex may need to increase. China Mobile (CHL): SECTOR: Emerging Markets; COUNTRY: China: We exited this position as we became concerned over rising capex trends at the company and the potential for additional government intervention in the telecom sector. A deteriorating Eagle rank allowed us to redeploy to more attractive opportunities. Nippon Telegraph & Telephone (NTT): SECTOR: Telecom Services; COUNTRY: Japan: Renewed competition in the industry in addition to high capex requirements led us to downgrade our expectations for future free cash flow and one of the key pieces of the thesis surrounding NTT, increased shareholder remuneration. PostNL NV (PNLYY): SECTOR: Industrials; COUNTRY: Netherlands: Deteriorating mail trends in the Netherlands and the rejection of the UPS bid for PostNL from European regulatory agencies leaves PostNL in a tough situation and prompted us to sell and redeploy to better opportunities.
Vodafone Group PLC (VOD): SECTOR: Telecom Services; COUNTRY: U.K.: We added to our position in VOD as the potential to finally solve the lack of operating control of Vodafone’s business - that is Verizon Wireless JV, could prove to unlock significant value at the Vodafone level.
Eagle Global Advisors, LLC
5847 San Felipe, Suite 930 Houston, TX 77057
713-952-3550
www.eagleglobal.com
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