First Eagle Overseas Fund 2nd Quarter 2022 Commentary

Market Overview

Financial markets continued to stagger in the second quarter. Though the pain was broad-based, the suffering was felt most acutely in the stock markets, which posted the worst first half of a year since 1970.¹ The S&P 500 Index and the MSCI World Index both slipped into bear markets during the period as they lost an additional 16.1% and 16.2%, respectively. Meanwhile, many of the first quarter’s equity market dynamics continued to be felt in the second, most notably the significant outperformance of value relative to growth.

We believe the fall from grace across asset classes thus far in 2022 largely has been the result of the normalization of what had been extraordinarily supportive conditions—including the shift away from generationally low costs of capital and energy.

With central banks led by the US Federal Reserve seeking to tame multidecade-high inflation by dampening aggregate demand, interest rates have moved higher across the yield curve, raising the cost of capital for businesses and consumers that also are contending with energy prices about double what they were 12 months ago. At the same time, there has been in unwind of the massive fiscal stimulus that had helped fuel markets’ rebound from the Covid swoon; the US budget deficit is forecast to fall to 4.8% of GDP in 2022 and 3.8% in 2023, down from 12.4% in 2021 and approaching the 50-year average of around 3.5%.²

Toward the end of the second quarter and into the beginning of the third, however, tighter financial conditions appeared to inspire fear not just of an inflation-dampening economic deceleration but of a full-fledged recession. Indeed, we have begun to see signs that fiscal tightening and higher interest rates are causing demand to soften; in the US, for example, consumer sentiment has deteriorated, manufacturing activity is slowing and mortgage applications are down.³

The impact of recessionary concerns was most evident in the bond markets. After climbing near 3.5% by mid-June—from close to 1.5% to start 2022—the 10-year US Treasury finished the first half of the year near 3.0%, a rally that suggests to us that markets expect central bank policy restraint to come to a premature end in the face of withering economic growth.⁴

Market Summary	2nd Quarter 2022
MSCI World Index	-16.19%
MSCI EAFE Index	-14.51%
S&P 500 Index	-16.10%
German DAX Index	-11.31%
French CAC 40 Index	-8.92%
Nikkei 225 Index	-4.94%
Brent Crude Oil	+6.39% ($114.81 a barrel)
	-6.72% ($1,807.27 an ounce)
US Dollar	+11.93% vs. yen; +6.43% vs. euro
Source: Bloomberg, WM/Reuters.

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Get Back

We think that a return to the conditions that prevailed in the aftermath of the Covid-19 swoon—namely, moderate inflation and a very low cost of capital—may be further away than some may think. In fact, things may get worse before they get better, especially if we are on the cusp of recession as some fear, suggesting a more complicated investment environment looking forward.

Many of the components of core CPI—such as healthcare, education, entertainment and rent—are quite sticky and may not be as quick to soften as commodity-driven inputs, which could keep inflation prints elevated even as non-core elements ease.

A more accommodative Fed combined with a widening current account deficit could weigh on the dollar, pushing the cost of imports higher and adding to inflationary pressures. The Fed balance sheet remains a concern as well; despite flat money supply growth in 2022, we estimate there are about $5 trillion or so in excess reserves as a result of pandemic-related accommodations, and whatever surplus remains at the end of the current Fed tightening cycle may be fodder for future inflation pressures.

However, our most pressing inflationary concern may be the fiscal deficit. While the Congressional Budget Office forecast for the deficit, mentioned earlier, is relatively sanguine, it’s not hard to envision multiple sources of negative drift that could push the deficit as a percentage of GDP back into the double digits.

Debt- servicing costs appear biased higher as low-rate Treasury debt matures and is replaced by issuance with yields in the 2–3% range. An increase in unemployment off current low levels could slash tax revenues while increasing expenditures in the form of automatic stabilizers, while the country’s aging demographics have a similar two-pronged effect on revenues and expenditures. Meanwhile, the capital gains tax windfall paid on 2021 market gains seems unlikely to be repeated next year, taking another chunk out of the revenue basket.

Of course, other considerations are playing out beyond US shores. While it seems to have fallen from the headlines, the war between Russia and Ukraine continues to impact market dynamics, as evinced by steady decline of the euro versus the US dollar over the course of 2022. Already struggling under the weight of high prices, Europe will soon head into colder weather with the potential threat of a cutoff in gas supply hanging over its head. On the flip side, this prospect may prompt European leaders to pressure Ukraine into reaching some sort of peace agreement with Russia.

China, meanwhile, has pivoted from contractionary policy to once again stoking its economic engine; not coincidentally, China was one of the few equity markets to deliver a positive return in the second quarter.⁵ That said, it’s unlikely that China will provide the type of stimulus it did in 2008–2009, which catapulted the country out of its global financial crisis slump and bolstered the global economy. Further, the periodic lockdowns’ associated with the country’s zero-Covid policy may continue to cause disruptions to global supply chains.

Planting Seeds

While the market’s year-to-date swoon has been painful, the selloff created opportunities for us to put money to work in companies we expect to perform well over the long term, allowing us to enlarge certain existing exposures and to add new ones.

Ultimately, we feel good about the prospects for the securities we own and the prices we paid for them, and as a result we are comfortable enduring the uncertainty we see in current financial markets.

Portfolio Review

Overseas Fund A Shares (without sales charge^*) posted a return of -9.05% in second quarter 2022. All regions detracted from performance, with notable weakness in developed Europe.

Performance across economic sectors was broadly negative; materials and financials were the leading detractors. The Overseas Fund outperformed the MSCI EAFE Index in the period.

Leading contributors in the First Eagle Overseas Fund this quarter included Prosus N.V. Class N (OTCPK:PROSY), Alibaba Group Holding Ltd. (BABA), BAE Systems plc (OTCPK:BAESF), Danone S.A. (OTCQX:DANOY) and CK Asset Holdings Limited (OTCPK:CHKGF).

Amsterdam-based Prosus is a technology investment firm and subsidiary of South Africa’s Naspers (OTCPK:NPSNY). Its largest holding is a near-30% stake in Chinese technology firm Tencent Holdings (OTCPK:TCEHY), in which it was an early investor. Prosus shares rallied on the announcement that it would sell a portion of its Tencent shares over time to fund the repurchase of its own stock; the share buyback program is intended to narrow the significant and persistent discount between the price of Prosus stock and the net asset value of its investment holdings.

Separately, Prosus sold off its entire 4% stake of Chinese ecommerce business JD.com (JD), which it had received as a dividend from Tencent.

The shares of Chinese e-commerce giant Alibaba advanced on signs that the Chinese government may be starting to relax its regulatory crackdown on the technology sector. There have been reports that Beijing’s more accommodative stance may re-open the door to the initial public offering of Ant Group, a leading Chinese online payment platform whose planned 2020 IPO was scuttled by regulators.⁶ Alibaba owns about one-third of Ant. We continue to like Alibaba’s core assets, including its cloud business, which continue to generate strong cash flows.

BAE Systems is the largest defense contractor in the UK. The company’s large, long-term fixed contracts with governments generate recurring revenue streams and provide cyclical resilience. Heightened geopolitical tensions have driven expectations for increased defense spending globally, which has been a tailwind for the stock. In addition, rising long-term interest rates have eased the company’s pension liability, removing an overhang from the stock.

French food giant Danone rallied along with its consumer staples peers as investors rotated into defensive stocks during the second quarter. Though the company faces headwinds from high raw material costs and supply chain constraints, its size and market share provide it with opportunities to mitigate the impact of these challenges. Danone is in the early stages of a multi-year turnaround plan to reshape its portfolio of businesses through acquisitions and divestments and greater investment in the brands it retains, which could help support pricing power and margins over the long term.

CK Asset Holdings, a real estate developer based in Hong Kong, derives the bulk of its profits from activities in Hong Kong and mainland China. Its shares reacted positively to the easing of pandemic-related restrictions in these locations, as well as a rebound in the performance of its overseas holdings. The company has also seen a significant increase in income from its infrastructure and utilities assets, located primarily in Europe, which tend to benefit during inflationary periods. We have been pleased with the company’s active stock buyback program during the second quarter.

The leading detractors in the quarter were gold bullion, Groupe Bruxelles Lambert SA (OTCPK:GBLBF), Nutrien Ltd. (NTR), Newmont Corporation (NEM) and Ambev SA Sponsored ADR (ABEV).

After rallying in February and early March as investors sought perceived safe havens in anticipation of Russia’s invasion of Ukraine, the price of gold bullion drifted steadily lower in the second quarter. While geopolitical discord remains a potential tailwind for the price of gold, the headwind of Fed rate hikes and aggressive inflation-fighting rhetoric drove real interest rates higher and proved to be the more powerful force during the second quarter.

Notably, gold continued to decline late in the quarter even as real interest rates gave back some of their gains on rising recessionary concerns; gold often weakens in advance of a recession, as markets digest the potential trajectory of monetary policy going forward. Gold still trades at a discount to many risk assets on a historical basis, and we continue to believe strongly in its utility as a potential hedge.

Based in Brussels, Groupe Bruxelles Lambert is an investment holding company that primarily owns stakes in publicly traded European companies, adidas (OTCQX:ADDYY) and Pernod Ricard (OTCPK:PDRDF) among them. GBL shares have underperformed on concerns about Europe’s vulnerability to slowing economic growth, inflation pressures and the conflict in Ukraine.

In addition, we saw the discount between GBL’s share price and the net asset value of its holdings widen during the quarter, a “double discount” typical of holding company stocks during challenging markets. We believe GBL’s portfolio of companies is of high quality and have been encouraged by the company’s aggressive stock buybacks in recent years.

Based in Canada, Nutrien is both the world’s largest producer of potash (and a major player in nitrogen and phosphate) and the world’s largest agricultural retailer. Nutrien shares declined as crop and fertilizer prices began to recede from the multiyear highs that accompanied Russia’s invasion of Ukraine. We continue to like Nutrien’s ability to generate cash flow and its network of high-quality, low-cost mines that allows the company to maintain growth optionality based on price conditions.

Shares of Colorado-based Newmont, the largest gold miner in the world, experienced weakness in the quarter as falling gold bullion prices and cost inflation hurt miners in general. More idiosyncratically, the company reported slightly disappointing earnings and production results for its most recent quarter due to pandemic-related disruptions, ongoing supply-chain constraints and labor shortages.

It also warned that operating costs for 2022 were likely to come in at the upper end of previous guidance. We remain constructive on the stock, which offers steady production anchored in good jurisdictions, a good pipeline of organic projects, a strong balance sheet and proven management.

Brazilian brewer Ambev, a subsidiary of Anheuser-Busch InBev, posted better-than-expected earnings for its most recent reporting period driven by improvements in both pricing and volumes. Its stock declined during the quarter, however, weighed down by such Brazil-centric issues as a new wave of Omicron variant infections, high domestic inflation, a weakened real and national elections in October. We were encouraged that Ambev continued to gain market share despite disruptions associated with Covid and the cancellation of Brazil’s Carnival festivities in April.

We appreciate your confidence and thank you for your support.

Sincerely,

First Eagle Investments

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Average Annual Returns as of Jun 30, 2022
				YTD	1 Year	5 Years	10 Years	Expense Ratio*
First Eagle Overseas Fund	Class A	without sales charge	SGOVX	-10.27%	-10.80%	2.09%	4.71%	1.16%
First Eagle Overseas Fund	Class A	with sales charge	SGOVX	-14.75%	-15.26%	1.05%	4.17%	1.16%
MSCI EAFE Index				-19.57%	-17.77%	2.20%	5.40%

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Footnotes

1Source: Dow Jones Market Data; data as of June 30, 2022. 2Source: Congressional Budget Office; data as of June 30, 2022. 3Source: Bureau of Labor Statistics, Institute for Supply Management, Mortgage Bankers Association; data as of June 30, 2022. 4Source: Bloomberg; data as of June 30, 2022. 5Source: MSCI; data as of June 30, 2022. 6Source: Bloomberg; as of June 9, 2022 * Performance for Class A shares without the effect of sales charges and assumes all distributions have been reinvested, and if a sales charge was included values would be lower.

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Original Post

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.