Commentary

Global Strategy

December 31, 2020

THE MARKET ENVIRONMENT

Similar to the year 2016, 2020 was a year of extremes driven by exogenous factors ranging from the Covid-19 pandemic to Brexit negotiations with elections in between. Most recently, markets reacted favorably to events in the fourth quarter, particularly the approval and emergency use authorization of multiple vaccines aimed at preventing the spread of Covid-19.

Meanwhile, the U.K. and European Union negotiated arduously in the quarter, finally accomplishing an agreement that eliminated the possibility of a hard Brexit outcome. In the U.S., the four-year presidential election cycle produced a more balanced outcome than many had expected. The market proved relieved at both the elimination of uncertainty and the lower probability of big changes. Later in the fourth quarter, President Trump signed the country’s long-debated second economic relief bill into law, sending direct payments to some individuals and families as well as further extending unemployment benefits.

These events propelled equity prices higher across the globe for a strong finish to a year that had earlier experienced a bear market. Ultimately, the Nikkei 225 Index soared to a 30-year high in Japan, the German DAX Index surged to a record figure, and both the Dow Jones Industrial Average and S&P 500 Index closed out the year at record levels.

This year amounted to a volatile 12 months for investors. Though traumatic and difficult to tolerate, we recognize that market instability can unearth investment opportunities for those who are patient and willing to weather the storm. In times when others chase performance or lose conviction based on news headlines and irrational reactions, we remain alert to subsequent opportunities caused by short-term investors to build positions in quality companies that are trading at large discounts to our perception of their intrinsic value. This discipline is deeply embedded in our philosophy and process.

THE PORTFOLIO

Top Performers:
Early in the quarter, Glencore released a nine-month production update with output for copper and zinc that outpaced market expectations, while nickel, coal, ferrochrome and oil fell short of forecasts. Management adjusted full-year guidance for coal to be lower and left all other projections unchanged. We found nothing remarkable in the update, and management’s guidance remained largely aligned with our estimates. Later, Glencore and China-based GEM announced a five-year partnership extension for the supply of cobalt. During its annual investor update in December, Glencore revealed the upcoming retirement of current CEO Ivan Glasenberg in June of 2021. While we did not find the announcement itself surprising, the timing is earlier than we had anticipated. The company attributed the short timeline to the combination of the establishment of the next generation of management (all internal appointments) with the recovery and strength of the business today. We appreciate that the newly appointed CEO Gary Nagle has a history in the coal business (similar to Glasenberg) and has been with Glencore his entire career. The company noted the emphasis on decarbonization will benefit Glencore as the International Energy Agency’s transition scenario anticipates demand for copper to double from 2019 to 2050. In our view, the company remains attractively priced given positive market trends and the potential to unlock value internally.

CNH Industrial’s third-quarter earnings report bested investors’ expectations and was solid, by our measure. Results were driven primarily by the agriculture equipment business where local currency revenue increased by nearly 14% in the third quarter (following a decline of 11% in the first half), helped by higher commodity prices, various government support programs and demand for replacement equipment. Agriculture earnings improved over 80% year-over-year as margins expanded from 6.2% to 10.1%. In addition, segment performance in the near term looks promising as order books are up double-digits in all four regions. In the construction equipment business, performance improved in comparison to the first half of the year, and the Iveco business experienced a strong recovery in the European light truck market, which advanced 7%. Free cash flow amounted to nearly $1 billion in the third quarter, which was an almost $2 billion improvement year-over-year. Later, we discussed the transition to new CEO Scott Wine (former chairman and CEO of Polaris) with Chairman and interim CEO Suzanne Heywood, who believes Wine’s broad experience at Polaris provides the background necessary for his role at the company. CNH’s strategy will remain intact under Wine, reaffirming a commitment to split the on-highway business into a separate company and the aggressive financial targets announced in September of 2019, though the timeline for achieving these goals was pushed back.

In our view, BNP Paribas delivered a strong third-quarter earnings report that highlighted the benefits of a diversified business model overseen by a strong management team. Revenue exhibited an acceleration of positive trends and increased 2.1% from a year ago, while costs shrank by about 2.4% for the period. Notably, revenue for the year-to-date period was ahead of our expectations, despite negative currency effects of 120 basis points. Underlying revenue growth was driven by 1% annualized loan growth year-to-date in addition to strength in the corporate and institutional banking segment that more than offset lower interest rates. The stronger revenue environment coupled with cost controls resulted in an advance of pre-provision profit, which was up a robust 8.6% for the year-to-date period. BNP’s balance sheet and capital position remain in very good shape illustrated by its common equity Tier 1 ratio that increased 20 basis points to 12.6%. In conjunction with this solid set of operating results, BNP’s share price also rose from positive Brexit deal developments in the quarter. A late-period trade agreement between the U.K. and European Union secured a new economic and security partnership, which reassured investors.

Bottom Performers:
Alibaba Group released fiscal second-quarter earnings results that were mixed, in our view, though revenue, adjusted earnings and earnings per share all outpaced market forecasts. Highlights included total revenue growth of 30% from last year, partly driven by a 20% revenue advance in the core e-commerce business that exceeded overall market growth of 17%. Adjusted earnings rose 28% year-over-year and annual active consumers increased 9%. However, we found it disappointing that the operating margin contracted from a year ago, which management attributed to business reinvestments. Later, Alibaba’s share price declined sharply as the company faced regulatory challenges that stemmed from the new anti-monopoly law in China. In addition, the suspension in November of the highly anticipated initial public offering of Ant Group, in which the company holds an approximately one-third ownership stake, also caused investor concern. The increased regulations on both Alibaba and Ant are still in the consultation phase and have not yet been finalized. While we find it difficult to accurately quantify the associated risks, we believe it is likely Alibaba will face greater regulatory scrutiny and slower growth going forward. However, the company remains an important driver of innovation in China and even considering the slower growth, we believe its valuation is compelling. In the meantime, we continue to monitor the situation, which remains fluid.

Bayer’s share price dropped significantly at the beginning of the fourth quarter when management issued preliminary 2021 guidance. Management’s forecast included revenue at roughly the same level as 2020 and constant currency earnings per share that were roughly 10% lower than market forecasts, which upset investors. Furthermore, the company plans to write-down crop science intangible asset values by billions of euros, which negatively surprised investors. Even so, we like that management introduced a new, incremental EUR 1.5 billion annual savings program (as of 2024) to rightsize operational infrastructure. Later, Bayer’s third-quarter revenue, adjusted earnings and earnings per share all missed market expectations. We saw the company’s results as mixed with improvement in pharmaceutical operations and ongoing robust performance in the consumer health business offset by weakness in the crop sciences segment. We were pleased that management effectively controlled costs and that the company confirmed full-year 2020 currency adjusted total revenue and earnings guidance. We recently spoke with Norbert Winkeljohann, who became chairman of the Supervisory Board early in 2020. We discussed his plans to enhance organizational alignment and agility by utilizing key performance indicator measures at deeper operational levels in the business. We think these initiatives can strengthen Bayer’s performance going forward.

Fresenius Medical Care realized third-quarter revenue that met market expectations, while earnings and earnings per share exceeded market forecasts by 2% and 5%, respectively. We saw results as mixed. The international and care coordination segments returned to growth, but Covid-19 weighed on treatment volumes in the U.S. Total revenue was relatively unchanged from the prior year, while net income rose 6% and earnings per share advanced 9%. However, organic revenue growth in the core North American dialysis service business contracted, which reflected a deceleration from the second quarter and partly stemmed from lower than normal referral rates, which investors found concerning. Although we view this issue as temporary because patients will eventually need dialysis services, the current slowdown dampens Fresenius’ pipeline and softens near-term growth.

During the quarter, we initiated new positions in Alibaba Group and Novartis. We eliminated Baidu from the portfolio.

Past performance is no guarantee of future results.

The Nikkei Stock Average (Nikkei 225) is a price-weighted average of 225 Japanese companies listed in the First Section of the Tokyo Stock Exchange. Constituents are selected based on liquidity and industry representation. This index is unmanaged and investors cannot invest directly in this index.

The Deutsche Boerse AG German Stock index is an equity index that measures the share performance of the 30 largest German companies in terms of exchange turnover and market capitalization, and is thus an established indicator for the performance of the German economy as a whole. This index is unmanaged and investors cannot invest directly in this index.

The Dow Jones Industrial Average is a price-weighted measure of 30 U.S. blue-chip companies. The index covers all industries except transportation and utilities. This index is unmanaged and investors cannot invest directly in this index.

The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 U.S. large-capitalization stocks representing all major industries. It is a widely recognized index of broad, U.S. equity market performance. Returns reflect the reinvestment of dividends. This index is unmanaged and investors cannot invest directly in this index.

The specific securities identified and described in this report do not represent all the securities purchased, sold, or recommended to advisory clients. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time one receives this report or that securities sold have not been repurchased. It should not be assumed that any of the securities, transactions, or holdings discussed herein were or will prove to be profitable. Holdings are representative of Harris Associates L.P.’s Global composite as of 12/31/20.

The information, data, analyses, and opinions presented herein (including current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) are for informational purposes only and represent the investments and views of the portfolio managers and Harris Associates L.P. as of the date written and are subject to change without notice. This content is not a recommendation of or an offer to buy or sell a security and is not warranted to be correct, complete or accurate.