Please find below the notes from GAM’s Weekly Investment Meeting on 9 May 2018 – this week’s speakers were Mirjam Heeb, commentating on a positive start to the year for the health innovation sector, and Fabien Weber, discussing the reasons behind the renewed interest in commodities.
Friday, May 11, 2018
Mirjam Heeb – Senior Portfolio Manager
The sector had a strong start to the year. At the annual JP Morgan healthcare conference held in January the guidance for the biopharmaceutical sector in particular was very positive. We also saw some M&A deals completed early in the year. However volatility has since returned alongside volatility in the wider equity markets and there were some larger clinical data readouts which disappointed, which also put something of a damper on the biopharma sector. Overall Q1 was mixed but generally positive. The growth we are anticipating to come through with new products is not particularly transparent despite valuations looking attractive.
There are a diverse range of subsectors within heathcare: equipment and supplies, providers and services, biotech, pharmaceuticals, life sciences tools and services and technology. Our core focus is on innovation within the sector. One measure of when something is truly innovative is when you have to go back and rewrite scientific textbooks. This is specifically the case with gene therapy, which moved from hope to reality in 2017 with the first gene and cell therapy products launched in the US which are approved and accessible for the treatment of diseases.
We have seen some validation of this within the industry, with Gilead Sciences’ acquisition of Kite for USD 12 billion in August 2017 and Genesis Energy buying Juno for USD 9 billion in January this year. Both are cell therapy companies, neither of which were generating any revenue at the time of purchase. It will be interesting what value and sales are generated by these companies in coming years. In addition the regulatory environment is very positive, with the FDA (Food and Drug Administration) being very pro-industry and innovation friendly. It is putting a lot of effort into moving products through quickly, with new designations being created, and getting them launched if there is sound scientific data to show they could be accessible to patients. Expensive products are being paid for when they show they can demonstrate a positive result. All this is helping the innovation cycle move more quickly than it has in the past.
This is the landscape we are trying to move around in, where there is the potential for growth albeit with some issues that need to be dealt with. US tax reforms have been a big topic, with the repatriation of tax being viewed as very positive. M&A could pick up as a result and will continue to be a driver for the sector, but targets are scarce and valuations high. We will watch for smart moves justified by compelling underlying technology. President Trump is also committed to lowering the cost of drugs while stimulating competition, going after the “middleman” such as insurers and pharmacy benefit managers in order to preserve innovation. In addition Amazon, Berkshire Hathaway and JP Morgan are planning to create an independent non-profit joint venture healthcare offering available to employees at low cost. This could be the first move into what could be a transition to a more efficient, value-based US healthcare system.
We feel we are in the early days of an expansion phase in the biopharma investment cycle. We will need to be a little more patient to see momentum growing in healthcare innovation and further top-line growth. Valuations are attractive both on an absolute and relative basis, with the valuation for the sector currently at 18 times earnings. Over the next 12 to 24 months we should see this growth start to come through.
Fabien Weber - Portfolio Manager
We have observed renewed interest in commodities over the last six months and believe this is largely down to the asset class being a late cycle performer. The current economic expansion is nearly 10 years old and it is clearly time for commodities to outperform, not just on relative terms but also on an absolute basis. The pick-up in inflation – most notably in the US – is also beneficial.
From an absolute perspective, commodity prices are very cheap (and even more so when factoring in inflation) – which is shown by analysing the ‘all time high’ for each commodity sector compared with today’s prices. From this analysis we can see that crude oil, at a current value of around USD 70, is trading at a discount of approximately 50% below its all time high of USD 140 in 2008. This is a similar scenario to nearly all of the commodity sectors, where the discount ranges between 30 and 80%. In fact there are only a few instances, such as palladium and lumber, where prices are near or above their all time highs. Therefore, in absolute terms, commodities are cheap but we believe they are also attractive on a relative basis.
When we compare the return of commodities versus equities (S&P 500), there have been two major cycles where commodities have outperformed – in the 1970s and late 1990s through to 2006. Considering the position today, commodities are very cheap relative to equities and therefore it is not surprising that in 2018 we have seen commodities start to outperform both equities and fixed income and expect this to continue going forward.
This expectation is based on strong fundamentals. Unlike other assets, commodities do not discount the future, but price the present. Therefore by analysing the forecasts of global investment analysts, we are able assess the supply/demand balance and see how this can change over time. In 2015 most commodities sectors were in surplus – this state of oversupply stemmed back to 2008 when prices were high and companies (typically energy and mining) started to invest. Such investment often takes several years to have an impact and this new supply only started to hit markets in 2014/15 – a time when the world economy was not as strong, demand was lower and prices declined. These lower prices meant companies stopped investing and over the next few years surpluses started to clear, inventories decreased and our analysis now indicates a deficit position across numerous sectors.
Commodities investments are actually futures positions, rather than physical assets. Since 2015 the carry for commodities futures has been negative or in contango (the spot price is lower than the future price). In today’s market we believe this negative carry is approaching breakeven for most sectors and, in the case of energy, clearly positive. It is only some agricultural sectors – such as wheat and corn – which remain in contango, although even these are starting to turn.
Focusing on oil, OPEC has, in recent years, sought to lower inventories back to their five-year average; now this goal has been achieved, OPEC still wants to scale back supply, alongside other non-OPEC suppliers, by around 2%. As a result, inventories are trading down, the market is in deficit and could tighten further if OPEC does not change its stance, which would be positive for crude prices. This could be further impacted by news that the US is pulling out of the Iran nuclear deal and is likely to re-impose sanctions on Iran. The effect of these sanctions may not be as severe as in the past if the EU and other nations continue to support the deal. Moreover, Iran is still expected to remain a key exporter to China, Turkey and India, who may not respond to US sanctions. Finally, the sanctions are subject to a 180 day wind-down period and so the effects will not be seen clearly until the end of the year.
Industrial metals is another sector where the balance between demand and supply is becoming more attractive - our analysis suggests the market is at its most undersupplied position in 20 years. However, prices have not risen as would be expected, an outcome we attribute to concerns about Chinese growth expectations.
Agriculture has been a drag on the market for the last two years thanks to benign weather conditions allowing supply to flourish. Agriculture prices tend to respond to concerns about the supply pipeline rather than changes in demand, which remain broadly stable. We are now seeing more balance in supply and demand and a positive impact on prices reflecting weather problems in South America (it was an abnormally dry season in Argentina, which is the third largest producer of soya beans), the Ivory Coast, which produces cocoa beans, and also the US, where wheat production was impacted. The next six months are critical for the growing season therefore any disruptions could also have a positive impact on prices.
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