The scene was set for an ebullient year in 2019 for risk assets by the very dark finish to 2018. Virtually every major, liquid asset class declined in value in 2018, and much of this weakness came in the fourth quarter. What was missed amidst those that were selling is that the Central Bankers around the world were hearing the message. They were coming to the rescue. Thus arrived the theme of 2019 - More acquiescent central bankers. The priming of the asset market pump was increasingly led by the Federal Reserve of the U.S., the same Central Bank that some feared had been raising interest rates too significantly and too quickly in 2018. As a result, investors in 2019 experienced the broadest rally in risk assets of the last decade. See Below.
We at Ballina Capital were pleased one year ago with the company valuations that had become much more attractive. While the U.S. S&P 500 forward P/e Ratio had declined to a much more reasonable level of 15.3x, we wondered at the time if International equities were poised to outperform U.S. equities. Unlike other very profitable “risk on” years such as 2009, 2012 and 2017 (see table above), International Equities were not able to outperform U.S. equities in 2019. It’s very possible that the clouds relating to the Trade War, Brexit and a general manufacturing and export malaise were just too much for European and Asian equities to outperform those of the U.S.
At Ballina Capital, we remain just as concerned about the outlook for markets. We are, more selectively than a year ago, constructive on the company level valuations (see below) we are finding today in our fundamental research today. Think of the themes that have scared off equity investors over the past few years – Brexit, the Trade War between the U.S. and China, traditional retail under threat from online sales. The valuation anomalies highlighted here all are heavily maligned from these thematic concerns. Crest Nicholson, a UK housebuilder, for example, has new executive leadership, and is moving forward with a strategy to improve margins and returns from the business under, ideally, a more favorable backdrop in the home market. Bed Bath & Beyond and Signet Jewelers are U.S. retailers that are at different stages of turnarounds. The environment for retailers has been anything but easy, but these are retailers where they have advantages. Bed Bath & Beyond has been meaningfully undermanaged for a long time, but it has a new and highly credible CEO. Kernel Holding is a very intriguing agriculture and emerging market equity story that has endured a cyclical downturn in earnings. Wilhelm Wilhelmsen is a conglomerate where all of it’s businesses are exposed to global trade volumes. All five companies highlighted below trade for at most 1x book value. They all have a history of returning their cost of capital. If we avoid tipping into a global recession in 2020, these stocks will be well placed to appreciate.
All five companies mentioned above are Small Cap equities. The largest has a $2.2bn market cap. These companies also share two very attractive characteristics that we look for at Ballina, but don’t always find, in that they have: a) strong free cash flow generation relative to overall firm value, and b) have some positive momentum in their fundamentals after some difficult years. We believe this combination sets these stocks up to perform relatively well. Given their low valuation, assuming the global macroeconomic environment remains reasonably stable, this group has significant upside potential. Many of the Ballina portfolio companies appear to us to be biased to appreciate in value if China and Europe can re-inflate in 2020. Very few would expect the U.S. economy to accelerate from here. Expectations for China and Europe are where we could have a surprise. Europe’s manufacturing economy is highly sensitive to China (see below), and if a Phase One trade deal and stimulus in China provide a decent amount of momentum, industrial recoveries tend to be V-shaped. International Equities could be the only good value play in 2020.
Source : Alpine Macro
International All-Cap Value returned 5.88% (gross basis) in December 2019 versus 4.39% for the benchmark. Year to date performance was 22.1% (gross) versus 21.75% for the benchmark.
Global Small Cap Value returned 6.18% (gross) in December 2019 versus 4.07% for the benchmark. Year to date performance was 21.94% versus 23.47% for the benchmark.
Top Contributors and Detractors
International All-Cap Value’s top contributor in December 2019 was Galliford Try. The UK construction business returned 20% in the month of December as it is selling it’s Housebuilding business to a larger player in the sector. The top detractor in the strategy was YY, Inc. The stock declined -13.5%, giving back much of it’s gains from November.
Global Small Cap Value’s top contributor in December was Bed Bath & Beyond. The U.S. home goods retailer returned 19.8% in December as new management pushed forward with aggressive restructuring steps. The top detractor in the strategy was Chico’s FAS. The stock declined -18.6% as the U.S women’s fashion retailer gave back gains from November. Chico’s was the leading contributor in the strategy in November.
 Benchmark for Global Small Cap Value comprised of 50% weight iShares Russell 2000 Index (IWM) and 50% weight Vanguard FTSE All-World ex-US Small-Cap ETF (VSS)