Market Overview
- After a strong six-month rally, international equity markets were broadly flat in the second quarter.
- While corporate profits were generally better than expected, investors focused more on short term macro and political concerns.
- Japan underperformed in dollar terms as local market performance was overwhelmed by continued yen weakness.
- Emerging Markets outperformed developed markets, both in the quarter, and now year to date, led by China which rose 7.1%.
- The European Central bank lowered their policy rate 25 basis points (bps), ahead of the US Federal Reserve.
International equities digested some of their recent gains in the second quarter. The MSCI EAFE Index fell 0.4% while the MSCI ACW ex-US Index rose 1.0%. Consensus estimates for 2024 and 2025 earnings rose modestly through the second quarter earnings season as companies, on balance, reported better-than-expected results. While corporate earnings for developed markets are only expected to grow 4% in 2024, that growth rate is expected to accelerate to 9% next year.
Despite the fact that the Bank of Japan raised short term interest rates for the first time in 17 years in March, the yen fell more than 6% during the second quarter, bringing the year-to-date loss for the currency to over 14%. While local Japanese returns have been strong due to rising inflation and improving corporate governance, USD returns have been negatively impacted by the currency weakness.
As the market shifted away from Japan, emerging markets outperformed developed markets the most in a quarter since 2016. Chinese equities led the way rising 7.1% in the quarter, due to continued government stimulus and dramatically lowered market expectations already reflected in valuations.
With inflation subsiding, the European Central Bank pivoted and cut rates 25 basis points this quarter. While future rate cuts are still a debate in the market, the central bank has signaled that the aggressive rate hiking cycle is over, which should provide increased confidence for investors. As the US Fed continues to push out rate cuts, the ECB is leading the rate cutting cycle for the first time in 25 years.
Portfolio Review
We have been talking about how the extreme environment, led by either expensive growth or low quality, should transition to a more fundamentally driven market benefitting our Portfolio. This was certainly the case for the six-month period of fourth quarter 2023 and first quarter 2024. However, the current short- term focus of the market on elections and central bank policy decisions has led investors to simply rely on what has worked in the recent past as opposed to focusing on the quality of the business and its long-term earnings power. Stocks with high price momentum, have been, by far, the largest driver of performance in international equity markets this year. The spread in performance between the MSCI EAFE Momentum Index (which aims to reflect performance of stocks with high price performance over the past twelve months) and the MSCI EAFE Index is the largest in 20 years, outside the extreme COVID rally in 2020. This has led the larger stocks in the MSCI EAFE Index to outperform which, in turn, has led to a nearly 5% spread in year-to-date performance between the MSCI EAFE index and the MSCI EAFE Equal Weighted index -the largest spread in more than 20 years. We strongly believe this is unsustainable and the average stock should close the gap with the Index going forward.
The Lazard International Equity Select Portfolio (MUTF:LZSIX) fell 1.7% in the second quarter, underperforming the MSCI ACWI ex-US benchmark, which fell 0.4%. (Portfolio return is measured net of fees and in US dollar terms.) We still believe the international equity market continues to be driven by fundamentals as opposed to style, which should be supportive for our relative value strategy over the medium to long term. However, during the second quarter, the market has been more focused on short term concerns like elections and lingering COVID supply chain issues, rather than the long-term earnings power of great businesses.
We have substantial weights in many of these great companies but still have room to add when companies indicate the short-term pressures have lifted and normal order patterns have resumed. For instance, AON and Ryanair (RYAAY), two long-term holdings in the Portfolio, have experienced some short-term pressures due to slower than expected growth. While we have not added to these compounders on the pullbacks yet, we are watching for the turn and hope to add when the fundamentals reaccelerate. Additionally, a few of our companies domiciled in emerging markets were temporarily impacted by elections, which introduced short-term volatility into those markets. We believe these concerns will fade.
Positives
Stock selection in the information technology sector positively contributed to relative returns. ASM International (OTCQX:ASMIY, 0.9% weighting in the Portfolio) is a semiconductor capital equipment manufacturer in the Netherlands. Shares rose after the company reported first quarter results. First quarter orders came in higher than consensus expectations and revenues came in at the top end of guided range as China strength helped margins. We trimmed our position post a period of great performance in order to right size a large position.
Taiwan Semiconductor Manufacturing (TSM, 5.1% weighting) is the global leader in semiconductor manufacturing and is the only independent foundry capable of serving customers looking to fabricate semiconductors on advanced nodes. Shares rose after the company reported first quarter results and management reiterated their growth expectation. Lack of inventory related commentary indicated how far the industry is moving past the previous downturn and AI continued to be an important growth driver. We maintained our position and belief that our long-term investment thesis remains intact. Stock selection in the communication services sector positively contributed to relative returns.
Domiciled in China, Tencent (TCEHY, 2.5% weighting) is one of the largest technology companies globally. Tencent dominates the Chinese internet space with an estimated ~50% share of all time online being spent within the Tencent family of apps. Tencent has one of the strongest ecosystems in both consumer and enterprise internet technology. Their diversified revenue streams help mitigate regulatory risk in any single division. Shares continued to rise in through the second quarter after reporting earnings in late March. Management commented visibility on their outlook appears to be improving and discussed their continued plans to step up capital returns to shareholders. These results are supportive of our investment thesis, and we maintained our position.
Negatives
High conviction companies where market was focused on short term: Shares of Ireland-based global Insurance broker Aon (1.9% weighting) declined after reporting first quarter results where organic growth came in below consensus expectations. Long term, we believe our investment thesis remains intact. As a broker and an asset- light company in a fairly consolidated industry, Aon generates strong returns on capital, which we believe will be sustained due to strong pricing power (particularly in its insurance brokerage business) and cash flow generation and may benefit from margin expansion opportunities longer term as they digest the NFP acquisition. We maintained our position.
Ryanair (1.7% weighting) is the leading European low-cost passenger airline. Shares underperformed largely on lower fare growth assumptions for the first half of 2025, which is in part due to the timing of Easter, and slightly higher non-fuel cost inflation driven by Boeing delays. Overall, we believe Ryanair can continue to grow EPS well into the double digits and is long-term an attractive business to own as the low-cost intra-European airline that continues to gain share.
Emerging market domiciled companies where elections introduced short-term market volatility: Banorte (OTCQX:GBOOY, 1.5% weighting) is a bank in Mexico. Shares have underperformed on macroeconomic fears resulting from the presidential election despite the fundamentals of the company remaining intact. First quarter results were strong with ROE of 22.2%, NIM (net interest margin) sensitivity to lower rates fell again attributed to active management, NPL (non-performing loan) ratio was down to 0.9% of fees and insurance revenues were very strong. Capital of 15.5% CET1 offers both EPS growth and a high dividend yield. We maintained our position and belief that our long-term investment thesis remains intact.
Mandiri (PPERF, 1.4% weighting) is an Indonesian bank. Shares underperformed after the company reported first quarter results and lower their NIM (net interest margin) guidance. We believe the fundamentals of the company remain intact and the market is expecting a one-off instance to continue to weigh on margins going forward, which we believe is not the case. We maintained our position and belief that our long-term investment thesis remains intact.
Outlook
ECB rate policy could provide the bump quality cyclicals need Geopolitical risk shifts from international to US International valuations remain near all-time lows compared to the US As international risks subside, investors should shift focus to deeply discounted valuations and longer-term earnings power
Style extremes have eased over the past year but more recently investors have been too focused on short-term issues and less willing to recognize the attractive valuation and earnings power of some high-quality cyclicals. As a result, the market has become more narrowly focused on simply what has worked in the recent past driving the price momentum factor to extreme levels. We think this will change.
Global economic growth is low, but positive. Interest rates, which are at a more normal level than they were during the pandemic, are broadly stable to heading lower, not higher. And in this environment, we have been able to find many great investments across the three alpha buckets of compounders, mispriced, and restructuring stories. Compounders have generally done well but some cyclicals have lagged due to the market’s focus on short-term concerns. We believe these companies can, and will, perform better as investors shift their focus away from short term noise. As the ECB has already begun to lower rates, and international elections are behind us, we believe many of these mispriced international equities with deeply discounted valuations and significantly higher earnings power can outperform.
We believe our portfolio is well-balanced for the different market outcomes. Having this balance should enable stock selection to drive performance. We still expect that outperforming stocks will broadly come from companies with strong pricing power, companies that can deliver in-line or better than expected margins and companies with less levered balance sheets. And the extremely discounted valuations for international stocks should provide support for international equities going forward.
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Important Information Please consider a fund’s investment objectives, risks, charges, and expenses carefully before investing. For more complete information about The Lazard Funds, Inc. and current performance, you may obtain a prospectus or summary prospectus by calling 800-823-6300 or going to www.lazardassetmanagement.com. Read the prospectus or summary prospectus carefully before you invest. The prospectus and summary prospectus contain investment objectives, risks, charges, expenses, and other information about the Portfolio and The Lazard Funds that may not be detailed in this document. The Lazard Funds are distributed by Lazard Asset Management Securities LLC. Information and opinions presented have been obtained or derived from sources believed by Lazard Asset Management LLC or its affiliates (“Lazard”) to be reliable. Lazard makes no representation as to their accuracy or completeness. All opinions expressed herein are as of the published date and are subject to change. The performance quoted represents past performance. Past performance does not guarantee future results. The current performance may be lower or higher than the performance data quoted. An investor may obtain performance data current to the most recent month-end online at www.lazardassetmanagement.com. The investment return and principal value of the Portfolio will fluctuate; an investor’s shares, when redeemed, may be worth more or less than their original cost. Different share classes may have different returns and different investment minimums. Please click here for standardized returns: https://www.lazardassetmanagement.com/us/en_us/funds/mutual-funds/lazard-international-equity-select-portfolio/F125/S38/ Allocations and security selection are subject to change. Mention of these securities should not be considered a recommendation or solicitation to purchase or sell the securities. It should not be assumed that any investment in these securities was, or will prove to be, profitable, or that the investment decisions we make in the future will be profitable or equal to the investment performance of securities referenced herein. There is no assurance that any securities referenced herein are currently held in the portfolio or that securities sold have not been repurchased. The securities mentioned may not represent the entire portfolio. Equity securities will fluctuate in price; the value of your investment will thus fluctuate, and this may result in a loss. Securities in certain non-domestic countries may be less liquid, more volatile, and less subject to governmental supervision than in one’s home market. The values of these securities may be affected by changes in currency rates, application of a country’s specific tax laws, changes in government administration, and economic and monetary policy. Emerging markets securities carry special risks, such as less developed or less efficient trading markets, a lack of company information, and differing auditing and legal standards. The securities markets of emerging markets countries can be extremely volatile; performance can also be influenced by political, social, and economic factors affecting companies in these countries. The MSCI All Country World ex-US Index (ACWI ex-US) is a free-float-adjusted, market capitalization-weighted index designed to measure the performance of developed and emerging equity markets outside the United States. The index is unmanaged and has no fees. One cannot invest directly in an index. The MSCI EAFE Index (Europe, Australasia, Far East) is a free-float-adjusted market capitalization index that is designed to measure developed market equity performance, consisting of developed market country indices excluding the United States and Canada. The index is unmanaged and has no fees. One cannot invest directly in an index. Certain information included herein is derived by Lazard in part from an MSCI index or indices (the “Index Data”). However, MSCI has not reviewed this product or report, and does not endorse or express any opinion regarding this product or report or any analysis or other information contained herein or the author or source of any such information or analysis. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any Index Data or data derived therefrom. Certain information contained herein constitutes “forward-looking statements” which can be identified by the use of forward- looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “target,” “intent,” “continue,” or “believe,” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events may differ materially from those reflected or contemplated in such forward-looking statements. |
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