THESE FUND MANAGERS SEE STARS ALIGNING FOR VALUE INVESTORS,
FUND MANAGERS SEE THE STARS ALIGNING
There is no debate that the world has seen anemic growth since the financial crisis. Central banks around the world helped avoid a global depression with various rounds of quantitative easing and other monetary stimulus, but that wasn’t enough to stave off a drawnout recessionary environment.
Yet long- held concerns about participation rates in the U.S. continue to fade, employment numbers are improving, and the housing market is still showing signs of strength.
Meanwhile, Europe is no longer in the midst of deflation, and important economies such as Germany and France are getting more healthy. Consumer confidence in France is at its highest level since 2007, for example.
As for China, the implosion that many feared has not materialized. The country is still adjusting away from traditional heavy industry, toward more consumer- oriented businesses, but with consumer spending up double- digits, auto sales running at a healthy clip, and online spending up well over 20 per cent, the case for a hard landing is becoming more difficult to make.
“In a nutshell, the global economy is not getting worse. It’s actually doing better, and it’s not just a U.S. phenomenon,” said Richard Wong, portfolio manager at Mackenzie Investments. “That environment is very constructive for value investing.”
Wong and Jonathan Norwood, who target out- of-favour stocks and beaten-up sectors, took over as co-leads of the Mackenzie Cundill team in March, 2016.
They run the flag ship $2.5- billion Mackenzie Cundill Value Fund, which trades at roughly two- thirds the benchmark MSCI World Total Return Index on a price- to- book value basis, and a few multiple points lower on a price-to-earnings basis.
In addition to their optimism about value stocks in general, the managers are bullish on cyclicals, and financials in particular.
The sector has recovered handsomely, especially since the Donald Trump and Republican victory in the U.S. elections.
Nor wood noted t hat Trump’s appointees on the fi- nance side — some of which are Goldman Sachs alumni — appear to be on the same page in terms of the belief that Barack Obama’s administration went too far when it came to reining in U.S. banks.
“The financial sun der George W. Bush went unfettered in terms of what they did with their balance sheets, lending standards, and investing with proprietary money alongside clients,” Norwood said. “That manifested itself during the credit crisis of 2007- 2008, and as expected the pendulum swung back the other way.”
The managers believe regulatory oversight will loosen, which along with higher interest rates, should benefit the banking sector.
“Someone also has to finance the increased infrastructure spending ,” Norwood said, noting that U.S. banks’ stocks still trade at a large discount to book value and intrinsic value.
The fund has positions in Bank of America Corp., American International Group Inc. and Citigroup Inc. — admittedly poster children for how not to run a financial institution during the crisis — but names that were purchased at very cheap valuations.
“They’ve cleansed their balance sheets incredibly, and are overcapitalized in our view,” Norwood said, noting that the stocks have upside potential of 50 per cent.
Another area of opportunity is the traditional media space, where Wong highlighted the fund’s position in 21st Century Fox Inc. (FOX/Nasdaq).
In recent years, investors have grown more concerned with the threat of cord- cutting and the popularity of online video providers like Netflix, when it comes to traditional television companies. However, Wong believes the data points to something different happening.
“Most households seem to have both, and use their over- the- top online service as a supplement to their cable TV,” he said.
Wong highlighted Fox’s library, which includes popular shows like 24 and the XMen movie franchise, as well as its sports franchise and Fox News offering.
“That is actually very important because in the new world of digital media, content has to come from somewhere,” he said. “We think Fox is very undervalued based on their sustainable cash flow, and the fact that advertising is probably going to be positive for them in a cyclical recovery.”
Healthcare has been another great place to hunt for value, as it’s been the worst- performing sector globally in the past year. Much of that stems from rhetoric courtesy of both Democrats and Republicans about drug pricing.
Wong highlighted McKesson Corp. ( MCK/ NYSE), which is the biggest player in the U. S. pharmaceutical distribution oligopoly.
“They are the middle-man and offer a lot of services,” he said, noting that McKesson has historically generated double- digit returns on equity, and has very little working capital needs. “It’s been a well- run business for a long time, so when it is under stress, that is the time to look at it.”
One industry the managers believe has been virtually left for dead by the market, is enterprise technology.
Like Microsoft, Adobe and Xerox before it, IBM Corp. ( IBM/ NYSE) is in the midst of a transition where its legacy businesses — mainframe computers and servers — is in secular decline.
At the same time, areas like software, cyber security, mobile, data analytics and cloud computing, are producing double-digit revenue growth.
So while IBM’s bottom line as a whole isn’t moving much, Norwood noted that the quality of its earnings is moving up the food chain.
“As that mix of higher growth and higher- valued businesses increases as a percentage of overall earnings, inevitably a light switch will go on i n some Wall Street analyst’s mind, and they will no longer consider IBM a hardware company,” he said.
Whereas IBM and other hardware companies trade at 10x earnings if they’re lucky, software companies typically trade at a P/ E between 15x and 20x.
“We believe there is a lot of embedded value there,” Norwood said, highlighting the company’s Watson computer system an unquantifiable asset.
“Nobody on the Street has any sense of what it’s worth, and we think it is worth a lot.
“Some people are afraid of it, but the market is becoming increasingly comfortable, and we’ve seen them use it in multiple applications,” he added, highlighting opportunities with IBM’s acquisition of The Weather Company. “Predictive analytics and cognitive- based business lines are the future.”