Global Strategy

September 2019

Major global markets finished mixed in the third quarter. August served as the most volatile month, bookended by relatively flat performance in July and September. Most recently, trade negotiations between the U.S. and China are providing a positive impact on global markets as the two countries agreed to restart trade negotiations in early October. Ahead of the planned trade talks, the U.S. delayed a planned tariff hike on Chinese goods from October 1 to October 15 in “a gesture of good will.” On the other hand, China exempted soybeans, cancer drugs and pesticides, among others, from tariffs on the U.S.

Despite the tempered situation between the U.S. and China, U.S. President Donald Trump made headlines for another matter late in September as a whistleblower brought to light the leader’s July telephone conversation with Ukrainian President Volodymyr Zelensky. In the call, Trump asked Zelensky to “look into” 2020 U.S. Democratic presidential hopeful Joe Biden and his son, news of which spooked investors. In response, Speaker of the U.S. House of Representatives Nancy Pelosi announced a formal impeachment inquiry on Trump to further delve into the matter. 

Elsewhere, the political crisis in the U.K. carried on as the U.K. Supreme Court ruled Prime Minister Boris Johnson’s suspension of Parliament earlier in the third quarter as unlawful. Once back in session, the body passed a law requiring Johnson to request an extension from the European Union (EU) on the U.K.’s current exit date of October 31, should the country fail to agree on a Brexit deal with the EU prior to the bloc’s summit on October 17-18. These ongoing situations stoked continued uncertainty surrounding global markets. 

Meanwhile, the European Central Bank opted to lower interest rates and ramp up quantitative easing at its September meeting, which prompted the euro to fall to a two-year low. The Federal Reserve also trimmed U.S. interest rates twice in the third quarter, while the Swiss National Bank and the Bank of Japan maintained negative interest rates in September. 

In our estimation, the lingering memory of the Great Recession is causing investors to be much more fearful than they should be at present. We see no signs of excesses in the economy that typically precede a recession. We believe the noise present today will dissipate and trade will ultimately flow more freely in the next several years. In the meantime, we weather the short-term distractions and volatility in pursuit of long-term results.

Top Performers:
Alphabet delivered strong second-quarter earnings results as revenue growth accelerated. Total revenue reached $38.94 billion, which bested analysts’ estimates for $38.15 billion in total revenues. Earnings per share ($14.21 vs. $11.10) also exceeded market expectations. Furthermore, the company’s operating margin of 24% was more robust than consensus expectations of 22.5%, and we found this achievement reassuring given CFO Ruth Porat’s recent comments about the possibility for increased sales and marketing expenses in the second quarter. Management also announced a new $25 billion share repurchase program with no expiration date, which added to our confidence in the team’s commitment to building shareholder value. In addition, we attended the company’s annual investor day where members of the executive team gave updates on several initiatives. Alphabet believes cloud computing provides significant growth potential and is on pace to deliver $8 billion in annual revenue. Notably, Thomas Kurian, CEO of Google’s cloud operations, predicts revenues can exceed $10 billion annually. Moreover, management remains confident in the health of the advertising/search business and is pleased that the company has maintained its leadership position in fundamental artificial intelligence. 

Taiwan Semiconductor reported second-quarter revenue of TWD 241 billion and earnings per share of TWD 2.57, which both outpaced market forecasts. Although revenue, earnings and the operating margin fell short of our estimates for the fiscal first-half period, we believe the company’s performance should strengthen going forward owing to already strong and growing demand for its new 7-nanometer (7nm) Fin Field-Effect Transistor, the first commercially available extreme ultraviolet process technology in the industry. Subsequent to the earnings release, Taiwan Semiconductor announced it is increasing capacity to produce 7nm chips as it received urgent orders for these processors from Bitmain Technologies, a producer of products for blockchain and artificial intelligence applications. Management stated that because the company has been struggling to meet existing demand, it would boost 7nm production by 10,000 units per month starting in November 2019. Late in the period, Taiwan Semiconductor stated that August consolidated revenues reached TWD 106.12 billion, which reflected a month-over-month revenue increase of 25.2% and a year-over-year increase of 16.5%. We are pleased with these positive revenue trends. 

Toyota Motor reported fiscal first-quarter results that outpaced our estimates and market expectations. Auto volumes increased 3%, net revenue rose 4% and operating income advanced 9% from the prior year. Margins also expanded 40 basis points. Importantly, margins improved by 130 basis points in North America after two years of weakness, which illustrated that management is beginning to achieve its key priority to rejuvenate margins in this critical market. Also, North American net revenues were up 1.5%. Net revenue grew 8% in the core Japan region (which includes exports), primarily led by strong volume growth in both Japan and export markets. In Europe, net revenue and volumes increased 10% and 8%, respectively, while margins improved 110 basis points. Despite these healthy results, management lowered full-year revenue, net income and operating income guidance owing to expected negative currency effects. However, we think management’s forecasts are quite conservative and we have left our estimates unchanged. Lastly, at the end of September, Toyota announced it bought back 43,347,500 shares, which completes its JPY 300 billion share repurchase program. 

Bottom Performers:
Daimler issued two profit warnings before releasing fiscal first-half results that, as predicted, were weak. Revenue of EUR 42.65 billion was slightly better than market expectations, while an earnings loss of EUR 1.56 billion led to negative earnings per share of EUR 1.24. Total revenue growth from industrial operations fell short of our estimates, driven by poor performance in the Mercedes-Benz segment, and margins were weaker than we had projected across the firm. However, revenue growth in the trucks, vans and buses segments all exceeded our forecasts. Subsequently, we met with CFO Harald Wilhelm and discussed the company’s current challenges and planned improvements and solutions. We also met with Arno van der Merwe, president and CEO of Beijing Benz Automotive, which is one of Daimler’s most important joint venture partnerships in China. We discussed several aspects of operations in China where it sells more than 600,000 cars and about 70% of which are manufactured there, which supports margin expansion. In our view, Daimler is a high-quality company with shares that are trading below our estimate of intrinsic value. 

Although investors reacted negatively to Glencore’s fiscal first-half total revenue, adjusted earnings and earnings per share that fell short of market expectations, we saw the results as mixed. Production was broadly in line with our expectations, while lower commodity prices hampered earnings – average prices declined across all key commodities, including copper (-11%), nickel (-11%), zinc (-16%), coal (-22%) and cobalt (-58%). Even though price levels are out of the company’s control, management has been watchful for supply disruptions and can adjust output accordingly. In addition, management has been working to calibrate production at three sites: Katanga (copper/cobalt in the Democratic Republic of Congo), Mopani (copper in Zambia) and Koniambo (nickel in New Caledonia), which has pressured margins and near-term profits. We expect this pressure will ease as production improves at these locations. Despite lower earnings, we were pleased that Glencore generated a healthy amount of free cash flow, which reached $3.1 billion at the end of the reporting period and was ahead of our estimates. Lastly, the company repurchased $1.3 billion of the current $2 billion share buyback plan and has intentions to complete the program by the end of 2019. 

Negative sentiment surrounding the energy sector along with volatile oil prices pressured Halliburton’s share price. However, considering the challenging business environment, the company’s second-quarter results released in late July were acceptable to us. Better than expected margins, primarily from completion and production operations, drove earnings per share 16% higher than market estimates, while total revenue was largely in line with projections. Management’s third-quarter revenue guidance was modestly below market forecasts, while margins met expectations. Management reiterated 2019 full-year guidance for free cash flow to match or exceed 2018 levels and foresees a continuing sequential decline for capital expenditures in 2020 that will be “down significantly” from 2019 levels (note that 2019 spending is projected to be roughly 20% lower than 2018 levels). Concurrently, management reaffirmed guidance for a high single-digit international revenue growth rate in 2019 and noted that a similar rate of growth in 2020 “seems reasonable,” while also highlighting pockets of improved pricing. Overall, we believe Halliburton’s positive trends are gaining some traction.

During the quarter, we established positions in Henkel and NAVER and also received shares of Prosus as a result of a Naspers spin-off. We eliminated Diageo and Willis Towers Watson from the portfolio.

Past performance is no guarantee of future results.


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