Welcome to First Eagle Reflections

Welcome to First Eagle Reflections

 

In my letter to you last year, I referenced the famous opening lines of Charles Dickens’s A Tale of Two Cities to highlight the extant dualities in the investment environment: Was it the “best of times” or the “worst of times”? In recent years, First Eagle has consistently warned of financial markets’ complacency in the face of mounting distortions and risks. With inflation that turned out to be more persistent than initially assumed and a newly resolute Federal Reserve, the balance in 2022 shifted to the “worst of times” for those unaccustomed to market corrections.

Mehdi Mahmud
Mehdi Mahmud, President and Chief Executive Officer

We think the equity markets’ pullback in 2022 largely represented a rational and mathematical response to higher interest rates. When rates are 0%, a $100 payout 10 years from now is worth $100 today; with interest rates at 4%, the same 10-year payout is worth only $60.

As the cost of money rose in 2022, assets with uncertain, option-like payoffs far in the future declined significantly in value, including some of the most speculative pandemic-era success stories—from special purpose acquisition companies (SPACs) to emerging tech names to cryptocurrencies. Meanwhile, stocks with consistent cash flows fared much better, as sectors like health care, consumer staples and materials demonstrated relative resilience in the challenging environment. At an aggregate level, the MSCI World Value Index outperformed the MSCI World Growth Index by more than 2,000 basis points year-to-date through November. 1

Bondholders may have been the cohort of investors most surprised by the year’s events. After 40 years of steadily declining yields, most market participants had a limited frame of reference for the Fed’s aggressive pace of rate hikes. For context, the Bloomberg US Aggregate Bond Index has lost money on an annual basis only four times since its inception 46 years ago, the worst of which was a decline of only 2.9%; year-to-date 2022 through November, the index was down 12.6%!2 We wonder the extent to which this episode will alter investors’ perceptions of risk in bond markets and structurally impact approaches to portfolio construction that were heretofore widely accepted, such as target date funds that tilt heavily toward supposedly “safe” fixed income investments for those in or near retirement. We have been wary of the very low yields available in public fixed income markets for some time and, in our view, were positioned appropriately for what transpired in 2022—whether through shorter-than-benchmark durations or exposure to floating-rate investments, depending on the specific mandate.

Though the Fed may have initially underestimated the persistence of inflation in the United States, it has since acted decisively and heads into year-end with a hawkish tilt. Despite this, futures markets currently assume that the fed funds terminal rate will peak shy of 5% before the central bank pivots to rate cuts in the second half of 2023.3 We think this can be interpreted in one of two ways: Markets are either 1) confident in the Fed’s ability to engineer a soft landing as it combats inflation, or 2) skeptical of the Fed’s resolve if the economy slows. While we don’t presume to be able to predict inflation, we note that the stickiness of prices, particularly in the labor market, could result in a more circuitous path toward target-level inflation than soft-landing proponents expect. Labor-availability issues have pushed wage inflation to levels nearly double their norm, and wages historically have been difficult to walk back without job losses or an economic slowdown.4

While conditions over the past year have been painful for owners of virtually all financial assets, such a cleansing reintroduces rational thinking into capital allocation and valuation and can be healthy over the long run. Covid-19— and the consequent policy reaction—unleashed a rapid and concentrated appreciation of speculative assets not seen since the dot-com bubble in 2000; however, it seems those widening relative valuations served to increase the velocity of their eventual snap back, like a rubber band stretched to its breaking point before release. Thus far, value stocks have been the primary beneficiary of the nascent mean reversion, led by the energy sector. As investors recalibrate their thinking to the new investment landscape, there are reasons to believe that future returns could be driven more by fundamentals than they have in recent years. Amid that backdrop, we think certain other long- neglected areas of the markets appear favorable—for instance, European equities, especially since Europe’s high inflation levels are largely due to war-related energy-supply constraints as opposed to labor market tightness or wage growth.

There’s no way of knowing if the worst is behind or lies ahead. Monetary policy takes time to transmit through the system, and it’s reasonable to expect that the Fed’s actions have yet to fully manifest in the economy. We are only just beginning to see the impact through lower housing and autos sales, and we likely need another few quarters to thoroughly gauge the impact of higher financing costs and tight labor markets on corporate earnings and growth trajectories. Meanwhile, numerous other risks persist—the war in Ukraine, ongoing global supply chain disruptions and a flagging Chinese property sector, to name a few—as does the potential for an idiosyncratic threat to emerge somewhere in what is already a less-forgiving environment.

So, to continue on the Dickens theme, do we have Great Expectations for the coming year? Not broadly, as we think the path ahead will remain volatile. We will continue to look for opportunities where we can find them, but we remain wary. As always, we seek to offer clients a differentiated range of investment strategies that meet their specific investment needs and we believe will demonstrate the potential for resilience through different states of the world. Across market cycles, macroeconomic conditions and disruptive events, we remain focused on our goal of delivering long-term shareholder value while avoiding the permanent impairment of your capital.

 

Sincerely,

Mehdi signature

Mehdi Mahmud
President and Chief Executive Officer,
First Eagle Investments
December 2022

1,2. Source: FactSet; data as of November 30, 2022.
3. Source: Bloomberg; data as of December 13, 2022.
4. Source: Bloomberg, Haver/Federal Reserve Bank of Atlanta, First Eagle Investments; data as of November 30, 2022.

 

 

The opinions expressed are not necessarily those of the firm and are subject to change based on market and other conditions. These materials are provided for informational purposes only. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice. Any statistics contained herein have been obtained from sources believed to be reliable, but the accuracy of this information cannot be guaranteed. The views expressed herein may change at any time subsequent to the date of issue hereof. The information provided is not to be construed as a recommendation or an offer to buy or sell or the solicitation of an offer to buy or sell any security. Past performance does not guarantee future results.

Risk Disclosures

All investments involve the risk of loss of principal.

The value and liquidity of portfolio holdings may fluctuate in response to events specific to the companies or markets, as well as economic, political or social events in the United States or abroad. During periods of market volatility, the value of individual securities and other investments at times may decline significantly and rapidly. The securities of small companies can be more volatile in price than those of larger companies and may be more difficult or expensive to trade.

A principal risk of investing in value stocks is that the price of the security may not approach its anticipated value or may decline in value. “Value” investments, as a category, or entire industries or sectors associated with such investments, may lose favor with investors as compared to those that are more “growth” oriented..

There are risks associated with investing in foreign investments (including depositary receipts). Foreign investments, which can be denominated in foreign currencies, are susceptible to less politically, economically and socially stable environments; fluctuations in the value of foreign currency and exchange rates; and adverse changes to government regulations.

Investment in gold and gold-related investments present certain risks, including political and economic risks affecting the price of gold and other precious metals, like changes in US or foreign tax, currency or mining laws, increased environmental costs, international monetary and political policies, economic conditions within an individual country, trade imbalances, and trade or currency restrictions between countries. The price of gold, in turn, is likely to affect the market prices of securities of companies mining or processing gold and, accordingly, the value of investments in such securities may also be affected. Gold-related investments as a group have not performed as well as the stock market in general during periods when the US dollar is strong, inflation is low and general economic conditions are stable. In addition, returns on gold-related investments have traditionally been more volatile than investments in broader equity or debt markets. Investment in gold and gold-related investments may be speculative and may be subject to greater price volatility than investments in other assets and types of companies.

Strategies whose investments are concentrated in a specific industry or sector may be subject to a higher degree of risk than funds whose investments are diversified and may not be suitable for all investors.

Diversification does not guarantee investment returns and does not eliminate the risk of loss.

Portfolio holdings are subject to change and should not be considered a recommendation to buy, hold or sell securities. Current and future portfolio holdings are subject to risk.

Alternative investments can be speculative and are not suitable for all investors. Investing in alternative investments is only intended for experienced and sophisticated investors who are willing and able to bear the high economic risks associated with such an investment. Investors should carefully review and consider potential risks before investing. Certain of these risks include:

  • Loss of all or a substantial portion of the investment;

  • Lack of liquidity in that there may be no secondary market or interest in the strategy and none is expected to develop;

  • Volatility of returns;

  • Interest rate risk;

  • Restrictions on transferring interests in a private investment strategy;

  • Potential lack of diversification and resulting higher risk due to concentration within one of more sectors, industries, countries or regions;

  • Absence of information regarding valuations and pricing;

  • Complex tax structures and delays in tax reporting;

  • Less regulation and higher fees than mutual funds;

  • Use of leverage, which magnifies the potential for gain or loss on amounts invested and is generally considered a speculative investment technique and increases the risks associated with investing in the strategy;

  • Carried interest, which may cause the strategy to make more speculative, higher-risk investments than would be the case in absence of such arrangements; and

  • Below-investment grade loans, which may default and adversely affect returns.

Active management is an investment management approach in which an investor, a professional money manager or a team of professionals tracks the performance of a investment portfolio and makes buy, hold, and sell decisions about the assets in it.

Asset-backed securities (ABS) are financial instruments collateralized by a pool of assets, such as mortgages, credit-card receivables, auto loans and student loans.

Bear market is generally defined as a period during which a market experiences a prolonged decline in price.

Bottom-up investing primarily considers factors affecting individual companies and secondarily focuses on industries and economic trends.

Bull market is generally defined as a period during which a market experiences a prolonged increase in price.

Collateralized loan obligations (CLOs) are financial instruments collateralized by a pool of corporate loans.

Consumer price index (CPI) is a measure of the average change over time in prices paid by consumers for a specific basket of goods and services. The core version of this index excludes more volatile food and energy prices.

Consumer price index (CPI) is a measure of the average change over time in prices paid by consumers for a specific basket of goods and services. The core version of this index excludes more volatile food and energy prices.

Diversification is a strategy that involves allocating assets to a variety of investments with the intention to help manage risk.

Federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight on an uncollateralized basis.

Floating-rate securities are financial instruments whose interest rate is adjusted periodically based on movements in an underlying reference rate.

Intrinsic value is based on a judgment of what a prudent and rational business buyer would pay in cash for all of a company in normal markets.

Margin of safety is defined by First Eagle as the difference between a company’s market value and our estimate of its intrinsic value. An investment made with a margin of safety is no guarantee against loss.

Mortgage-backed securities (MBS) are financial instruments collateralized by a pool of mortgages.

Passive Management is an investment management approach that seeks to mirror the performance of a designated index.

Special-purpose acquisition company (SPACs) are publicly listed entities formed solely to acquire one or more privately held companies.

Target-date funds are packaged asset-allocation products whose investment allocation shifts over time as their target date nears.

Treasury inflation-protected securities (TIPS) are a type of US Treasury issuance whose principal value is indexed to the rate of inflation.

Volatility is a statistical measure of the degree to which the return of a portfolio or individual security deviates from its mean over time. Indexes are unmanaged, and one cannot invest directly in an index.

Equity Indexes

MSCI EAFE Index measures the performance of large and midcap securities across 21 developed markets countries around the world excluding the US and Canada.

MSCI EAFE Growth Index measures the performance of large and midcap securities exhibiting overall growth style characteristics across developed markets countries around the world excluding the US and Canada. The growth investment style characteristics for index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate, long-term historical EPS growth trend, and long-term historical sales per share growth trend.

MSCI EAFE Value Index measures the performance of large and midcap securities exhibiting overall value style characteristics across developed markets countries around the world excluding the US and Canada. The value investment style characteristics for index construction are defined using three variables: book value to price, 12-month forward earnings to price, and dividend yield.

MSCI EAFE Mid-Cap Index measures the performance of midcap securities across developed markets countries around the world excluding the US and Canada.

MSCI EAFE Mid-Cap Growth Index measures the performance of midcap securities exhibiting overall growth style characteristics across developed markets countries around the world excluding the US and Canada. The growth investment style characteristics for index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate, long-term historical EPS growth trend, and long-term historical sales per share growth trend.

MSCI EAFE Mid-Cap Value Index measures the performance of midcap securities exhibiting overall value style characteristics across developed markets countries around the world excluding the US and Canada. The value investment style characteristics for index construction are defined using three variables: book value to price, 12-month forward earnings to price, and dividend yield.

MSCI Emerging Markets Index measures the performance of large and midcap representation across 21 emerging markets countries around the world.

MSCI EAFE Small Cap Index measures the performance of small cap representation across developed markets countries around the world excluding the US and Canada.

MSCI EAFE Small Cap Growth Index measures the performance of small cap securities exhibiting overall growth style characteristics across developed markets countries around the world excluding the US and Canada. The growth investment style characteristics for index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate, long-term historical EPS growth trend, and long-term historical sales per share growth trend.

MSCI EAFE Small Cap Value Index measures the performance of small cap securities exhibiting overall value style characteristics across developed markets countries around the world excluding the US and Canada. The value investment style characteristics for index construction are defined using three variables: book value to price, 12-month forward earnings to price, and dividend yield.

MSCI World Index measures the performance of large and midcap securities across 23 developed markets countries around the world.

MSCI World Growth Index measures the performance of large and midcap securities exhibiting growth style characteristics across 23 developed markets countries. The growth investment style characteristics for index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate, long-term historical EPS growth trend, and long-term historical sales per share growth trend.

MSCI World Value Index measures the performance of large and midcap securities exhibiting value style characteristics across 23 developed markets countries. The value investment style characteristics for index construction are defined using three variables: book value to price, 12-month forward earnings to price, and dividend yield.

Russell 1000® Index measures the performance of the large cap segment of the US equity universe. It is a subset of the Russell 3000® Index and includes approximately 1,000 of the largest securities based on a combination of their market cap and current index membership.

Russell 1000® Growth Index measures the performance of the large cap growth segment of the US equity universe. It includes those Russell 1000 companies with relatively higher price-to-book ratios, higher I/B/E/S forecast medium-term (two-year) growth, and higher sales per share historical growth (five years).

Russell 1000® Value Index measures the performance of the large cap value segment of the US equity universe. It includes those Russell 1000 companies with relatively lower price-to-book ratios, lower I/B/E/S forecast medium-term (two-year) growth, and lower sales per share historical growth (five years).

Russell 2000® Index measures the performance of the small cap segment of the US equity universe. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.

Russell 2000® Growth Index measures the performance of the small cap growth segment of the US equity universe. It includes those Russell 2000 companies with relatively higher price-to-book ratios, higher I/B/E/S forecast medium-term (two-year) growth, and higher sales per share historical growth (five years). 

Russell 2000® Value Index measures the performance of the small cap value segment of the US equity universe. It includes those Russell 2000 companies with relatively lower price-to-book ratios, lower I/B/E/S forecast medium-term (two-year) growth, and lower sales per share historical growth (five years).

Russell Midcap® Index measures the performance of the midcap segment of the US equity universe. It is a subset of the Russell 1000® Index and includes approximately 800 of the smallest securities based on a combination of their market cap and current index membership.

Russell Midcap® Growth Index measures the performance of the midcap growth segment of the US equity universe. It includes those Russell Midcap Index companies with relatively higher price-to-book ratios, higher I/B/E/S forecast medium-term (two-year) growth, and higher sales per share historical growth (five years).

Russell Midcap® Value Index measures the performance of the midcap segment of the US equity universe. It includes those Russell Midcap Index companies with relatively lower price-to-book ratios, lower I/B/E/S forecast medium-term (two-year) growth, and lower sales per share historical growth (five years).

S&P 500 Index is a widely recognized unmanaged index including a representative sample of 500 leading companies in leading sectors of the US economy. Although the S&P 500 Index focuses on the large cap segment of the market, with approximately 80% coverage of US equities, it is also considered a proxy for the total market.

Fixed Income Indexes
Bloomberg Global Aggregate ex-USD Bond Index measures the performance of investment grade debt from 24 local-currency markets. This multi-currency benchmark includes sovereign, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers. Bonds issued in US dollars are excluded.

Bloomberg US Aggregate Bond measures the performance of investment grade, US dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM passthroughs), ABS and CMBS.

Bloomberg US Corporate Bond Index measures the performance of investment grade, fixed-rate, taxable corporate bond market. It includes US dollar-denominated securities publicly issued by US and non-US industrial, utility and financial issuers.

Bloomberg US Corporate High Yield Bond Index measures the performance of the US dollar-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk are excluded.

Bloomberg US Long Treasury Index measures the performance of US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury with a maturity greater than 10 years.

Bloomberg US Mortgage Backed Securities Index measures the performance of fixed-rate agency mortgage-backed pass-through securities guaranteed by Ginnie Mae, Fannie Mae and Freddie Mac.

Bloomberg US Treasury Index measures the performance of US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury. Treasury bills are excluded by the maturity constraint but are part of a separate Short Treasury Index.

Bloomberg US Treasury Inflation-Linked Bond Index measures the performance of the US Treasury inflation-protected securities (TIPS) market. Federal Reserve holdings of US TIPS are not index eligible and are excluded from the face amount outstanding of each bond in the index.

Credit Suisse Emerging Market Corporate Index measures the performance of emerging market corporate debt that represents the characteristics, pricing and total return performance of different asset classes within the emerging market corporate universe.

ICE BofA AAA US Corporate Index measures the performance of US dollar-denominated investment grade rated corporate debt publicly issued in the US domestic market with a given credit rating AAA.

ICE BofA AA US Corporate Index measures the performance of US dollar-denominated investment grade rated corporate debt publicly issued in the US domestic market with a given credit rating AA.

ICE BofA Single-A US Corporate Index measures the performance of US dollar-denominated investment grade rated corporate debt publicly issued in the US domestic market with a given credit rating A.

ICE BofA BBB US Corporate Index measures the performance of US dollar-denominated investment grade rated corporate debt publicly issued in the US domestic market with a given credit rating BBB.

ICE BofA BB US High Yield Index measures the performance of US dollar-denominated below investment grade rated corporate debt publicly issued in the US domestic market with a given credit rating BB.

ICE BofA Single-B US High Yield Index tracks the performance of US dollar-denominated below investment grade rated corporate debt publicly issued in the US domestic market with a given credit rating B.

ICE BofA CCC & Lower US High Yield Index measures the performance of US-dollar denominated below investment grade rated corporate debt publicly issued in the US domestic market with a given credit rating CCC or below.

Real Asset Indexes
Alerian MLP Index is a capped, float-adjusted, market capitalization-weighted index designed to track the performance of energy infrastructure master limited partnerships (MLPs).

FTSE EPRA Nareit Global Real Estate Index is a float-adjusted, market capitalization-weighted index designed to track the performance of listed real estate companies in both developed and emerging countries worldwide.

FTSE Gold Mines Index measures the performance of the shares of companies whose principal activity is the mining of gold and encompasses all gold mining companies that have a sustainable, attributable gold production of at least 300,000 ounces a year and that derive 51% or more of their revenue from mined gold in the worldwide market.

FTSE Gold Mines EMEA Index is a subindex of the FTSE Gold Mines Index Series. It measures the performance of all gold mining companies that have a sustainable, attributable gold production of at least 300,000 ounces a year and that derive 51% or more of their revenue from mined gold across the Europe/Middle East/Africa (EMEA) region.

FTSE Gold Mines Asia Pacific Index is a subindex of the FTSE Gold Mines Index Series. It measures the performance of all gold mining companies that have a sustainable, attributable gold production of at least 300,000 ounces a year and that derive 51% or more of their revenue from mined gold across the Asia Pacific region.

FTSE Gold Mines Americas Index is a subindex of the FTSE Gold Mines Index Series. It measures the performance of all gold mining companies that have a sustainable, attributable gold production of at least 300,000 ounces a year and that derive 51% or more of their revenue from mined gold across the US, Canada and Latin America.

ICE US Dollar Index is a geometrically averaged calculation of six currencies weighted against the US dollar: the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.

S&P Global ex-US Property Index defines and measures the investable universe of publicly traded property companies domiciled in developed and emerging markets excluding the US. The companies included are engaged in real estate-related activities such as property ownership, management, development, rental and investment.

S&P Global Infrastructure Index measures the performance of 75 companies from around the world chosen to represent the listed infrastructure industry while maintaining liquidity and tradability. To create diversified exposure, the index includes three distinct infrastructure clusters: energy, transportation and utilities.

S&P Global Natural Resources Index measures the performance of 90 of the largest publicly traded companies in natural resources and commodities businesses that meet specific investability requirements, offering investors diversified and investable equity exposure across three primary commodity-related sectors: agribusiness, energy, and metals and mining.

S&P GSCI® is a composite index of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities.

Alternative Credit Indexes
Cliffwater Direct Lending Index is an asset-weighted index of more than 8,000 directly originated middle-market loans.

JPMorgan CLO Index is a total return benchmark for US dollar-denominated broadly syndicated, arbitrage US CLO debt.

JPMorgan CLO AAA Index is a subset of the JPMorgan CLO Index that only tracks the AAA rated CLO debt.

JPMorgan CLO AA Index is a subset of the JPMorgan CLO Index that only tracks the AA rated CLO debt.

JPMorgan CLO A Index is a subset of the JPMorgan CLO Index that only tracks the A rated CLO debt.

JPMorgan CLO BBB Index is a subset of the JPMorgan CLO Index that only tracks the BBB rated CLO debt.

JPMorgan CLO BB Index is a subset of the JPMorgan CLO Index that only tracks the BB rated CLO debt.

JPMorgan CLO B Index is a subset of the JPMorgan CLO Index that only tracks the B rated CLO debt.

Morningstar LSTA US Leveraged Loan Index is a market value-weighted index designed to measure the performance of the US leveraged loan market.

Morningstar LSTA US BBB Ratings Loan Index is a market value-weighted index designed to measure the performance of the US leveraged loan market for loans with BBB- to BBB+ ratings as rated by S&P Global Ratings.

Morningstar LSTA US BB Ratings Loan Index is a market value-weighted index designed to measure the performance of the US leveraged loan market for loans with BB- to BB+ ratings as rated by S&P Global Ratings.

Morningstar LSTA US B Ratings Loan Index is a market value-weighted index designed to measure the performance of the US leveraged loan market for loans with B- to B+ ratings as rated by S&P Global Ratings.

Morningstar LSTA US CCC Ratings Loan Index is a market value-weighted index designed to measure the performance of the US leveraged loan market for loans with CCC- to CCC+ ratings as rated by S&P Global Ratings.

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