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While the Israeli economy remains on a solid footing, momentum has slowed a bit, mostly due to global growth concerns. The manufacturing slowdown that has gripped most of the developed world appears to have caught up to Israel as well as the most recent Israel Manufacturing PMI index plunged to 44.3 in August from 52.2 the previous month. The Bank of Israel (BoI) agrees with the slower growth as it reduced its estimate for GDP growth for 2020 from 3.5% to 3% on the back of a global growth slowdown and on expectations the government may take steps to reduce the fiscal deficit which at over 3% remains stubbornly above desired levels.
The Bank of Israel has done an about face after sticking to its aggressive hawkish tone in the early part of the quarter, it now appears has shifted to a dovish tone with some observers even thinking that the BoI may lower rates sooner rather than later. While the benchmark rate sits at 0.25% there is not much room to lower rates. The Monetary Committee of the BoI noted in a recent release that “if necessary, the Committee will take additional steps toward making monetary policy even more accommodative…” Some expect foreign exchange intervention to come back in vogue as the shekel appreciation year to date has dampened exports and led to deflationary pressure. Inflation now at a low 0.6% over the last twelve months has disappointed and has caught the BoI by surprise making it more likely they will cut rates and provide more monetary accommodation in the near term.
As far as politics, the second national elections this year led to similar results of no party or coalition winning an outright majority. After days of significant negotiations, president Reuven Rivlin again handed prime minister Netanyahu the challenge to secure a coalition to rule the next Knesset. There are calls for a broad-based unity government while some think the prime minister may not be able to form a coalition and president Rivlin will then task Blue and White leader Benny Gantz with the goal of forming a ruling coalition. There is much uncertainty on the makeup of the next government.
Performance and Attribution
The Timothy Plan Israel Common Values Fund closely matched the performance of the TA-125 index for the quarter, maintaining its strong lead for the year to date period. Sector allocation was positive with good allocation in Technology, Health Care, and Energy while Stock selection was challenged from weakness in the Technology sector. Security and cyber-security plays such as Checkpoint Systems, Verint Systems, and CyberArk Software all took a pause in the quarter.
The strong economy continues to support robust corporate earnings growth. The labor market remains robust providing good visibility towards continued strong consumption. Some of the economic challenges are caused by the high demand in inward investment and new energy revenues that provide a good long term fiscal and trade tailwind. We remain constructive Israeli equities over the long term as the innovation of Israel corporates and the strong economic growth in the country supports equity prices.
Looking back, equity markets ended the quarter in positive territory despite continued concerns over the ongoing trade dispute and future economic growth given the deterioration of economic data. The U.S. market outperformed international equities and large caps fared far better than small caps. Investors continue to look for additional clues regarding the health of the economy given the longevity of the business cycle. The Federal Reserve cut rates twice during the quarter, marking the first time for such actions in over a decade. The market remains optimistic regarding additional future rate cuts in order to help bolster the economy. Interest rates fell sharply during the quarter, notably the yield on the 10-year U.S. treasury declined to 1.66%, falling 34 basis points over increasing demand for safe-haven assets amidst the uncertainty. The impact from macroeconomic uncertainty is clearly weighing on business confidence as company fundamentals have so far remained relatively resilient, while supporting the belief that earnings will be up year-over-year in 2019.
Looking forward to the end of the year and into 2020, earnings growth remains a key question for investors as earnings for the upcoming third quarter are once again slated to fall year-over-year. The prior two quarters saw positive surprises, relative to estimates, push growth back into positive territory but looking ahead, the market is still forecasting another year of strong growth into 2020. In contrast, the most recent GDP reading was for 2%, decelerating from the prior quarter, and other indicators such as the ISM’s PMI for manufacturing fell even farther into contractionary territory for the first time in nearly a decade. These, along with the trade disputes, continue to weigh on business confidence and have started to have some modest impact on consumer confidence as well. As the economic cycle continues to progress into its latter stages, the preference for high-quality, stable, and cash generative businesses are likely to increase even more so as markets become increasingly concerned for those companies with more challenged models. These differences, we believe, will cause further dispersion in returns between those companies best able to weather these uncertainties versus those who are not. We remain vigilant in assessing absolute risk in the securities we invest in and striving to protect client capital during these times for potential volatility from the uncertainty.
Timothy Plan Small Cap Value Fund Q3 2019 Commentary
During the third quarter, Utilities and Real Estate were the best performing sectors in the Russell 2000 Index while Energy and Health Care were the worst.
The portfolio’s relative performance benefitted from an underweight in Health Care and favorable stock selection in Industrials. J&J Snack Foods posted a strong quarter driven by strength in their frozen beverage portfolio. Easterly Government Properties moved higher on steady performance as the company continued acquiring government investment properties. Lattice Semiconductor rallied as their strong product pipeline and improving gross margins continued to exceed investor expectations. CONMED reported a beat and raise quarter with strong organic growth from their core areas of orthopedics and general surgery, as well as from their recent acquisitions. Federal Signal shares appreciated after the company posted accelerating orders on new product cycles and the potential for accretive acquisitions.
The portfolio’s relative performance was negatively impacted by an overweight in Energy along with less favorable selection. Consumer Discretionary also detracted from performance due to unfavorable selection. ProPetro shares declined as falling commodity prices continued to pressure spending by their core exploration and production customers. Callon Petroleum declined as well as the lower crude oil prices sent investors elsewhere in the market. Children’s Place faced headwinds as the promotional environment for children’s clothing remained high after the bankruptcy of Gymboree. Omnicell shares fell on investor concerns over deterioration in working capital metrics after a negative research report was published. Comfort Systems USA declined after some slowness in nonresidential construction caused sales and margins to fall short of expectations.
Past performance is not indicative of future results. Portfolio returns reflect the reinvestment of dividend and interest income. All information provided is for informational purposes only and is not intended to be, and should not be interpreted as, an offer, solicitation, or recommendation to buy or sell or otherwise invest in any of the securities/sectors/countries that may be mentioned. A description of the methodology used to calculate the attribution analysis or a complete list of each holding’s contribution to overall performance during the measurement period may be obtained by contacting firstname.lastname@example.org. Benchmark Data Source: © 2019 FactSet Research Systems Inc. All Rights Reserved. Russell Investment Group is the owner of the trademarks, service marks, and copyrights related to its indexes, which have been licensed for use by Westwood.