Global Value Improvers Strategy Commentary September 2024

Key Takeaways

• September was a positive month for global markets, as the beginning of the rate cut cycle in the U.S., news of upcoming Chinese stimulus and a broadening of market leadership helped bolster global equities broadly.  

• The Strategy outperformed its benchmark, as strong stock selection in North America and the industrials sector overcame detractors in health care and the United Kingdom.  

• Periods of heightened volatility remind us of the importance of portfolio diversification and the benefit of having longer term investment themes less tied to the economic cycle and lend stability during extreme market movements.

Market Overview

Global markets generated broadly positive returns in September, as the first rate cut by the Fed, investor enthusiasm over the prospect of additional Chinese stimulus and a broadening of market leadership outside of AI beneficiaries helped bolster equities. The MSCI World Index returned 1.83% (in U.S. Dollars), while the MSCI World Growth Index outperformed the MSCI World Value Index, returning 1.96% and 1.70%, respectively. 

In a widely telegraphed move to markets, the U.S. Federal Reserve cut interest rates by 50 basis points at its September meeting, its first rate cut since the early days of the COVID-19 pandemic in 2020, citing its progress on combating inflation along with a softening labour market as the impetus for the rate reduction. Additionally, comments by Fed Chair Powell were positively received by the market, as despite citing data dependency as the impetuous for future cuts, policymakers have left the door open for additional cuts in the future. The rate cuts helped spur a stock rally in U.S. markets which saw value stock outperform as equity leadership rotated beyond the concentrated AI beneficiaries that have led the market year-to-date and helped lift the performance of small and mid cap stocks. However, with the first rate cut in the rear view mirror, investors are now looking toward the contentious final months before the U.S. presidential election and what the permutations in political math may mean for policy on areas such as immigration, trade policies and economic regulators.

The Bank of Canada also cut rates in September and, while the Bank of England left rates unchanged, statements by BoE policymakers suggested that an additional rate cut would be likely before the end of the year. Finally, signs of slowing in inflation below the Reserve Bank of India’s target rate of 4% also made it a possible next candidate for rate cuts.

Despite continuing to see slowing economic momentum, with industrial production and retail sales both falling versus their August levels, Chinese stocks surged following the announcement of an unusually broad stimulus package aimed at revitalising the world’s second largest economy. In a seeming reversal from statements in August, the People’s Bank of China announced that it would cut benchmark interest rates and, along with its existing plan to lower bank reserve ratios, offer CNY500 billion in loans to brokers and insurers for equity purchases and another CNY300 billion to help listed companies finance share buybacks. Despite the CSI 300 Index having risen approximately 25% since the announcement, economists continue to be skeptical that investors’ enthusiasm can translate into a durable and sustained turnaround for the broader Chinese economy. However, some of the inflows were also attributable to the election of Shigeru Ishiba, a Liberal Democrat, to the position of Prime Minister in Japan. Investor concerns over Ishiba’s statements supporting higher taxation on investment income and concerns that he may not follow the corporate and economic policies of the previous administration contributed to a rotation in investor flows from the strongly performing year-to-date Japanese market into China.

Despite the European Central Bank also lowering interest rates, the second such cut in three months, signs of economic slowdown continued in Europe. German factory output continued to slide into its second straight quarter of contraction, contributing to a 0.3% decline in overall Eurozone industrial production (which would have seen a greater decrease if not for a sharp upswing from perpetually volatile factory orders in Ireland). Political drama also continued with the new French Prime Minister Michel Barnier reportedly considering an increase in the country’s corporate tax rate and a tax on share buybacks as means to help plug an expanding budget deficit, which weighed on the performance on French stocks.

Oil prices declined during the month, notching overall losses for the third quarter, as rising inventory levels in the U.S., continued lacklustre demand from China and the prospect of further production increases from OPEC+ members outweighed concerns about a widening of Middle East conflicts.

Within the benchmark, Asia Ex Japan was the best performing region while Japan proved the biggest laggard. The top performing sector was the materials sector driven by rising gold and silver prices, as the opportunity cost of holding non-yielding assets declined alongside interest rates, and by rebounds in the price of industrial metals like copper on an anticipated pickup in demand from the Chinese economy.

Portfolio Highlights

Against this backdrop, the ClearBridge Global Value Improvers Strategy outperformed its benchmark for the month, as strong stock selection relative to the benchmark helped bolster returns. On a regional basis, stock selection in North America, Japan and Europe Ex. U.K. benefited performance. Conversely, stock selection in the U.K. weighed on returns.

By sector, overall stock selection effects contributed to performance, with particularly strong performance coming from our industrials holdings including Vertiv (0.46%) and Nexans (0.44%). Vertiv, a global manufacturer of power, precision cooling and infrastructure management systems for mainframe computer, server racks and critical process systems, continues to benefit from the demand and buildout of data centres due to its strong position in the liquid cooling industry. Due to the company’s strong relationships with existing customers, ability to deliver products at scale globally, strong service network and continued research and development, the company has been able to build a strong backlog and continues to solidly execute on expectations. Likewise, Nexans, a French industrials company that makes cable systems for offshore wind farms, subsea interconnections, power transmission, telecom networks, fiberoptics and electrical systems, also continues to benefit from the long-term trends of electrification and the global energy transition. Most notably, one of Nexan’s largest projects, the Great Sea Interconnector, saw progress in negotiations on funding from the Greek and Cypriot governments, which had been a major source of investor concern.

Conversely, stock selection in the health care sector was the biggest detractor from returns. Multinational pharmaceutical and biotech company AstraZeneca (-0.49%) saw its share price decline after it announced that a Phase 3 study of their antibody drug coagulate, Dato-DXd, did not show a statistically significant outcome in helping extend the lives of breast or lung cancer patients. Gerresheimer (-0.45%) also moved lower, as the manufacturer of medicinal packaging and drug delivery devices issued a profit warning and cut forward guidance. The company is seeing a slower-than-expected rebound from the destocking trend that has plagued the industry for the past year, as well as negative impact from the flooding of its manufacturing plant in North Carolina caused by Hurricane Helene.     

During the month, we did not initiate any new positions or exit any existing holdings.

All returns are in local currency.

Positioning and Outlook

As markets continue to move higher and index concentration persists, we are wary of the imbalances of positioning in global markets entering a period of heightened political uncertainty and geopolitical instability. A widely contested US. presential election, potential U-turn in economic policy by the Chinese central government, and multiple ongoing wars that could escalate argue for caution, particularly as valuations feel relatively full. We remain disciplined on our valuation parameters but will be ready to act if heightened volatility presents opportunities to purchase high quality businesses or unique ESG enabler candidates at significant discounts to intrinsic value.

As the AI wave approaches its second anniversary, we are seeing a broadening of investment opportunities as the capacity constraint has moved beyond semiconductors and servers to now include power and infrastructure needed to support continued data centre builds. Simply put, existing power generation and grid infrastructure are insufficient to support AI capex growth forecasts, particularly in the U.S. We believe the need to balance these operational challenges with longer term sustainability objectives will increasingly force companies and investors to consider a more pragmatic, improvement-based approach to defining the ESG field.