Global Value

Market Commentary

Period ended December 31, 2019
 

MARKET COMMENTARY

For much of calendar year 2019, the United States engaged in a trade war with China, its largest global trading partner. Near the end of the year, the US House of Representatives impeached the President for just the third time in history.  The uncertain path of Brexit was the major political story in Europe throughout the year, though the UK’s Conservative party election victory removed a “worst case” economic scenario. Global equity markets largely shrugged off the tumultuous geopolitical landscape and the MSCI World Index returned an impressive +28%; only 4 calendar years since the index’s 1983 inception have been better. 

Multiple expansion explains essentially all of the market’s performance as the MSCI World’s forward P/E ratio (consensus estimates) increased from 14.3x to 18.2x during the year. The index now trades about 15% above its 20 year average P/E.  Importantly, however, interest rates are considerably lower than they have been for most of that period. The 10-year US treasury yield is just 1.9% compared to its 20-year average of 3.4%; the 10-Year UK Gilt yield is 0.8% compared to its 20-year average of 3.3%; the 10-year German Bund yield is -0.2% compared to its 20-year average of 2.6%. 

The technology sector led the way, by a large margin, returning +48%, though most sectors delivered strong performance.  Energy was the exception, returning +12%.  Over the past 3 years, energy was the index’s worst-performing sector, returning +1% compared to the overall index return of +43%, cumulatively. The second-worst performing sector during this time was financials with a +30% return. 

For the third year in a row, the MSCI World Growth Index outperformed the MSCI World Value Index (+33.7% vs. +21.7%).  Global growth outperformed value in 9 of the last 10 calendar years with cumulative outperformance of more than 70% (+186% vs. +112%, or +11.1% vs. +7.8% annualized). Nearly all of this occurred in the last three years.  The lopsided performance has resulted in a wider-than-normal valuation spread between growth and value.  Over the past 20 years, the average forward P/E for the MSCI World Growth Index has been 5.0x above that of the MSCI World Value Index.  As of 12/31/19, the forward P/E for the growth and value indices were 25.4x and 14.2x, respectively, or a spread of 11.2x.  Over the past 20 years, this valuation gap has been wider only 6% of the time (and only during the tech/internet bubble). Using price-to-book instead of price-to-earnings, the current valuation gap has been exceeded only 5% of the time historically, with the tech/internet bubble again representing the lone exception. 

Investors’ increasing preference for low stock price volatility explains at least a portion of the valuation gap’s widening. This has caused a substantial divergence between certain industries with many non-cyclicals exhibit rich risk-adjusted valuations relative to their cyclical counterparts.  As an example, the forward P/E ratio for MSCI World utilities has risen by 45% over the last decade while the forward P/E ratio for MSCI World banks has risen by 1% over the same period. We have nothing against utilities, consumer staples, or healthcare, other than the seemingly high prices currently required to purchase them.   

While the overall equity market appears fully valued compared to history, we believe the valuation disparities across the market create an investment environment highly conducive to long-term focused active management, particularly in relative terms. The spread between the growth and value indices is wide, suggesting a promising outlook for value.  The spread between the portfolio and the value index is also wide, suggesting a promising outlook for the portfolio. The portfolio trades at 7.8x normal earnings compared to the MSCI World at 17.4x normal earnings. The considerable valuation advantage combined with good underlying businesses and healthy balance sheets leaves us confident about the portfolio’s prospects, particularly compared to passive alternatives.  

ATTRIBUTION: 2019

The Hotchkis & Wiley Global Value portfolio (gross and net of management fees) underperformed the MSCI World Index in 2019, though it outperformed the MSCI World Value Index.  Two stylistic headwinds explain all the underperformance relative to the broad benchmark. First, value lagged growth, so our value focused approach was a considerable headwind relative to the broad/core benchmark. Second, there was an unusually strong correlation between company size and performance, with larger market cap companies outperforming smaller market cap companies.  MSCI World stocks that began the year with a market cap under $5 billion returned about +11% for the year, while stocks with a market cap over $100 billion returned about +34%.  The portfolio’s average weight in the smaller cap group was 19% compared to 8% for the index, while the portfolio’s average weight in the larger cap group was 16% compared to 39% for the index—the smaller cap bias was an insurmountable headwind during the year. From a sector perspective, the underweight position in technology and stock selection in energy detracted from performance; positive stock selection in financials and industrials, along with the underweight position in healthcare helped relative performance. The largest detractors to relative performance in the year were Whiting Petroleum, Danieli, Royal Mail, Embraer, and BMW; the largest positive contributors were WestJet Airlines, General Electric, Ophir Energy, Hitachi, and Microsoft.      

Composite performance for the strategy is located on the Performance tab. Returns discussed can differ from actual portfolio returns due to intraday trades, cash flows, corporate actions, accrued/miscellaneous income, and trade price and closing price difference of any given security. Portfolio characteristics and attribution based on representative Global Value portfolio. Certain client portfolio(s) may or may not hold the securities discussed due to each account’s guideline restrictions, cash flow, tax and other relevant considerations. Equity performance attribution is an analysis of the portfolio's return relative to a selected benchmark, is calculated using daily holding information and does not reflect management fees and other transaction costs and expenses.  Specific securities identified are the largest contributors (or detractors) to the portfolio’s performance relative to the MSCI World Index. Other securities may have been the best and worst performers on an absolute basis.  The “Largest New Purchases” section includes the three largest new security positions during the quarter/year based on the security’s quarter/year-end weight adjusted for its relative return contribution; does not include any security received as a result of a corporate action; if fewer than three new security positions during the quarter/year, all new security positions are included.  Securities identified do not represent all of the securities purchased or sold for advisory clients, and are not indicative of current or future holdings or trading activity.  H&W has no obligation to disclose purchases or sales of the securities.  No assurance is made that any securities identified, or all investment decisions by H&W were or will be profitable. The value discipline used in managing accounts in the Global Value strategy may prevent or limit investment in major stocks in the MSCI World, MSCI World Value, MSCI World Growth, MSCI World Bank and MSCI World Utilities indices and returns may not be correlated to the indexes. Quarterly characteristics and portfolio holdings are available on the Characteristics and Literature tabs. For a list showing every holding’s contribution to the overall account’s performance and portfolio activity for a given time period, please contact H&W at hotchkisandwiley@hwcm.com.  Portfolio information is subject to the firm’s portfolio holdings disclosure policy.
 
The commentary is for information purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Portfolio managers’ opinions and data included in this commentary are as of December 31, 2019 and are subject to change without notice.  Any forecasts made cannot be guaranteed.  Information obtained from independent sources is considered reliable, but H&W cannot guarantee its accuracy or completeness. Certain information presented is based on proprietary or third-party estimates, which are subject to change and cannot be guaranteed. Equity securities may have greater risks and price volatility than U.S. Treasuries and bonds, where the price of these securities may decline due to various company, industry and market factors.  Investing in value stocks presents the risk that value stocks may fall out of favor with investors and underperform growth stocks during a given period. The strategy invests in foreign securities which involve greater volatility and political, economic and currency risks and differences in accounting methods. All investments contain risk and may lose value. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI. See www.hwcm.com/definitions for full disclaimer.
 
Past performance is no guarantee of future results.
 

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