Earnings season reimagined
Corporate earnings results, tariffs, interest rates and oil prices were just some of the topics discussed on the latest Ivy Live broadcast. Watch the replay to hear our views.
Broad global markets witnessed steady growth in 2017 and 2018 seems to be following a similar growth trajectory. Many investors have questioned whether these growth trends can continue, given rising valuations, political turmoil and a move to tighter global monetary policy. In a changing investment landscape, we’ve shifted our investment outlook in an effort to balance opportunity with risks.
Looking back at 2017, the Fund’s positioning was balanced, relative to the index, between defensive and cyclical sectors. With momentum a stand-out performance driver across markets, this generated a headwind for the Fund’s “relative value” approach. The neutral allocation stemmed from our belief that equity markets did not reflect much of the potential looming geopolitical, inflation and extended economic cycle risks. These concerns continue today. Geopolitical issues, such as tensions in the Middle East, the North Korean situation and the Brexit negotiations, have added volatility to the marketplace, and the current economic cycle is in its 10th year — long by any historical standard. The question remains: How much longer will the cycle extend uninterrupted by looming risks? As a result, we are watching closely for signs of change and have made an effort to position the Fund to withstand an abrupt end to the cycle.
In 2017, cyclical sectors posted relative gains driven by economic growth leveraged into strong earnings growth. Specifically, the information technology, materials and industrials sectors solidly beat the index return for the year; the financials sector performed in line with the index; and staple sectors underperformed. In the end, cyclical sectors outperformed defensive sectors by more than 800 basis points on the year, based on the benchmark — the MSCI EAFE Index.
For 2017, the Fund posted a solid return in excess of 20% but lagged the Index’s return. From a sector standpoint, top contributors to performance included strong stock selection in information technology, consumer staples and consumer discretionary. Information technology holdings Alibaba Group Holdings Ltd. ADR and MercadoLibre, Inc. were standout performers. These allocations stemmed from our top-down viewpoint of attractive growth opportunities in emerging markets as well as perceived growth opportunities in companies linked to internet expansion. Within consumer staples, an allocation to Wuliangye Yibin Co. Ltd., a Chinese alcoholic beverage company, drove relative gains.
Geographically, our emerging-market positions drove positive performance. The asset class enjoyed gains in excess of 35% in 2017. Despite the strong growth, we remain constructive on the asset class as we move through 2018, and believe economic expansion has created pockets of opportunity. Of note, we have continued to add exposure to China at the expense of Europe. Chinese industrial policies, the inclusion of A-shares in emerging-market indices and perceived attractive valuations have driven the increase to the region, while perceived macroeconomic risks in the eurozone has resulted in the reduction to Europe. Heading into 2018, the Fund had an approximately 12% allocation to emerging markets and we expect to maintain a similar weighting throughout the year.
While our country allocations benefited performance, stock selection in health care and energy was a detriment to performance for the year. Allocations to Teva Pharmaceutical Industries Ltd. ADR and Seven Generations Energy Ltd. were top relative detractors, providing about 160 basis points of relative underperformance. The Fund’s allocation to health care was reduced during 2017, including selling Teva Pharmaceuticals, as poor relative earnings and uncertain growth prospects pressured the sector. Our viewpoint on the sector remains muted for 2018.
Despite select energy holdings proving to be a headwind to performance in 2017, we have increased the Fund’s allocation to the sector as we think there are many attractively valued stocks and/or growth opportunities.
From a top-down standpoint, we made a couple of changes to our investment themes in 2017. We eliminated the mergersand- acquisitions (M&A) theme and added “forces of market disruption” as a theme during the fourth quarter.
The “disruption” theme entails a closer look at five persistent forces driving threats to a company’s business model when evaluating potential investment opportunities. These forces include the internet, artificial intelligence/digitalization, the increasing role China plays as a competitor, persistent low cost of capital and nationalism. We believe these forces of disruption could impede a company’s long-term growth prospects.
In summary, current Fund themes include:
As we move forward, we continue to seek companies we believe should benefit from our top-down view and identified investment themes.
Despite perceived risks to equity markets, we believe global economic growth is in a sweet spot today, buoyed by global monetary and fiscal policy that remains at the extremes of easy. We do not anticipate material central bank policy changes unless inflation accelerates at a higher-than-expected rate. However, the majority of major central banks have begun or indicated a desire to taper their aggressive monetary policy. For instance, the U.S. Federal Reserve raised rates in December — the third time in 2017 — and consensus estimates expect an additional two to four hikes in 2018. Long term, virtually all countries are struggling with high levels of debt and we believe central banks will attempt to keep rates below nominal gross domestic product growth in order to monetize the debt. As such, we believe there is a long-term cap on how high rates can go. Our base case is continued slow, deliberate exiting of quantitative easing and reversing of negative interest rate policy globally.
Despite a year of solid gains, we believe relative valuation remains supportive for international equities, especially in emerging markets, while absolute valuations are less attractive. At a fundamental level, we are increasingly focused on companies with perceived sustainable competitive advantages and strong balance sheets as well as attempting to reduce our allocations to companies with high exposure to financial leverage — a strategy we believe to be effective at the end of an economic cycle.
Though market uncertainties remain, we believe our flexible investment approach, incorporating growth and value securities across the market capitalization spectrum, can drive shareholder value over time. As such, a balanced approach that weighs perceived opportunities with risks seems prudent.
Past performance is no guarantee of future results. The opinions expressed are those of the Fund’s portfolio managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through February 2018, are subject to change based on market conditions or other factors, and no forecasts can be guaranteed. The information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance, and time horizon.
Top 10 Equity Holdings as a percent of net assets as of 12/31/2017: Total S.A. 3.3%, Isuzu Motors Ltd. 2.5%, Koninklijke Ahold Delhaize N.V. 2.4%, Westpac Banking Corp. 2.2%, Orange S.A. 2.1%, Bayer AG 2.0%, Danone S.A.1.9%, Fuji Heavy Industries Ltd. 1.8%, Kabushiki Kaisha Mitsubishi Tokyo Financial Group 1.8 and Nestle S.A., Registered Shares 1.8%.
MSCI EAFE Index is an unmanaged index comprised of securities that represent the securities markets in Europe, Australasia and the Far East. Investments cannot be made directly in an index.
Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. International investing involves additional risks including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.