sitox
By Evan Bauman, Peter Bourbeau, Aram Green, & Margaret Vitrano
Truing Up Growth Exposures on Weakness
Market Overview
Growth stocks remained in favor in the second quarter, with enthusiasm over generative AI extending gains for mega cap companies in a historically narrow market. The S&P 500 Index rose 8.74% and the Nasdaq Composite climbed 13.1% as investors took cooling inflation to mean the Federal Reserve’s tightening cycle is near its conclusion. The benchmark Russell 3000 Growth Index maintained its positive momentum, advancing 12.47% and outperforming the Russell 3000 Value Index (+4.03%). Growth is ahead of value by 2,300 basis points year to date.
2023 has so far marked a return to the leadership of the largest growth stocks in the market: a handful of companies in the information technology (IT), consumer discretionary and communication services sectors. Year to date, the “Magnificent Seven,” as coined by CNBC’s Jim Cramer (Apple, Microsoft, Amazon.com, Google, Nvidia, Tesla and Meta Platforms), have accounted for 69.4% of the total return of the Russell 3000 Growth Index (Exhibit 1).
Exhibit 1: Mega Cap Performance Illustrates Concentrated Market
Data as of June 30, 2023. Source: FactSet.
At 39.1%, the five largest stocks in the market represent the highest concentration in the 36-year history of the Russell 3000 Growth Index. Among these names, we maintain overweights to Nvidia (NVDA) and Amazon (AMZN), underweights to Microsoft (MSFT) and Apple (AAPL) and no exposure to Alphabet (GOOG,GOOGL) .
While such concentration had been a headwind in the past, the ClearBridge All Cap Growth Strategy has seen improved performance through this latest high-beta-driven period of mega cap dominance due to improved stock selection and patience. Positioning activity through the COVID-19 recovery has been focused on balancing exposures between more disruptive, higher-growth stocks that provide greater participation in up markets with steadier compounders that can provide ballast during turbulent periods.
The Strategy underperformed in the first half of 2022 from being too early in entering several stocks going through negative earnings revisions and it has seen relative results rebound more recently due to better stock picking, especially among earnings reset names such as Netflix (NFLX) and Meta Platforms (META).
Supporting our widely held names in the second quarter were sizable contributions in industrials, where we saw solid performance from UBER, which is benefiting from greater market share in its core rideshare business. Eaton (ETN) moved higher on steady demand for its electrical components and rising share in the build out of greater electrification infrastructure. HVAC and building services provider Johnson Controls (JCI) and industrial parts supplier Grainger (GWW) also delivered solid share performance.
Portfolio Positioning
Quarterly results were partially offset by weakness among the portfolio’s consumer discretionary holdings as well as an IT underweight. We have been cognizant of our lower IT exposure and had purposefully been positioned this way in 2022 to manage the headwinds of rising interest rates and what we had expected to be a slowdown in enterprise IT spending. AI enthusiasm may now provide more of a floor on spending than previously anticipated and as a result we are now inching toward the middle from a previously defensive stance. This has involved leveraging opportunities to close the gap in our IT coverage.
Taking advantage of post-earnings weakness, we initiated a position in Intuit (INTU), a provider of software for small business accounting and tax preparation under the QuickBooks and TurboTax brands as well as personal finance (Credit Karma) and marketing services (Mailchimp). We see a clear path to upside earnings revisions as the company expands new products that increase its total addressable market and drive average revenue per user growth.
Top-heavy leadership has overshadowed weakness across much of the equity market. We leveraged the narrow breadth in the second quarter to increase our consumer discretionary exposure with the purchase of TJX, a leading off-price apparel and home furnishings retailer known for its TJ Maxx, Marshalls and HomeGoods brands, with 4,800 global locations. We see TJX as a differentiated retailer offering shoppers a combination of value and convenience with continued share gain opportunity against large addressable U.S. markets for apparel and home decor. We also see room for TJX to modestly expand margins on the back of sales leverage and as freight, shrink and wage pressures ease. While TJX is not immune to macro risks, we see the company as relatively well-positioned even in the event of an economic deterioration as benefits from better inventory availability and consumer trade-down accrue.
The addition of Pinterest (PINS), a social media platform for visual discovery that allows users to find ideas and inspiration, further diversifies our communication services exposure. We believe the company is poised to take share in the large and growing market for online advertising. Under the direction of new CEO Bill Ready, we see levers for improved user engagement and monetization. While he is relatively new to the company, we are encouraged by Ready’s track record in prior roles as well as early signs of progress from his efforts. Pinterest is profitable on a non-GAAP basis today, but we also see opportunities for meaningful margin expansion as revenue scales. Also within media, we consolidated our bets by exiting names for which we have less optimistic outlooks for growth — Liberty Media SiriusXM, Liberty Broadband (LBRDK) and AMC Networks (AMCX).
The sale of rideshare provider LYFT, similar to our moves in communication services, prunes a smaller position to consolidate the portfolio in our highest-conviction ideas. We initially purchased Lyft in May 2021 when rideshare volumes were still depressed due to COVID-19. While Lyft was a clear #2 behind Uber in domestic rideshare, we believed it was a cleaner way to play the U.S. recovery due to the focused nature of its business. However, poor execution and the uneven nature of the U.S. recovery, with West Coast markets where Lyft has historically had greater exposure lagging due to a lack of return to office work, further weakened its market position. In March, Lyft announced co-founder Logan Green would step down as CEO with David Risher, a former Amazon executive, taking his place. While Risher has laid out ambitions to drive Lyft’s market share higher, we believe doing so will require more than a few quarters. Furthermore, while the company has looked for areas to right size its cost base, we see necessary investments in price, service levels and product differentiation to drive this turnaround further pushing out the path to improved profitability.
Outlook
The economy is sending mixed signals, with a resilient job market and better than expected consumer spending thus far neutralizing the impact of restrictive monetary policy. With labor costs still too high to support the Fed’s inflation fight, Chairman Jay Powell expects at least two more interest rate increases in the second half of the year. Meanwhile, manufacturing has contracted for eight straight months and we remain cautious as the lagged effects of aggressive tightening have yet to be fully felt across the broader economy. Companies remain cautious about earnings, with 67 in the S&P 500 Index issuing negative guidance for the second quarter compared to 46 issuing positive guidance.
We continue to evaluate new opportunities in software, industrials and the consumer space and have refreshed our whiteboard, looking to take advantage of downside earnings revisions among early cycle recovery plays while scaling up newer positions amid volatility. We are targeting quality themes in the consumer space where estimates have been partly de-risked, similar to the scenario that prompted the purchase of Estee Lauder in the fourth quarter. Such names should be well-positioned to deliver improved earnings on the other side of an eventual recession.
While it is still early days to understand the full reach of generative AI, we own a number of companies that should benefit as businesses look to modernize their infrastructure and find ways to better exploit this technology. We believe our focus on identifying innovative companies with management teams investing for future growth positions the portfolio well for the long term as technology cycles like AI emerge.
Portfolio Highlights
The ClearBridge All Cap Growth Strategy underperformed its benchmark in the second quarter. On an absolute basis, the Strategy posted gains across eight of the nine sectors in which it was invested (out of 11 sectors total). The primary contributors to performance were the IT, communication services, health care and consumer discretionary sectors. The consumer staples sector detracted.
Relative to the benchmark, overall stock selection contributed to performance but was offset by negative sector allocation effects. In particular, an overweight to health care, an underweight to IT and stock selection in the IT and consumer discretionary sectors detracted from results. On the positive side, stock selection in the industrials, health care and communication services sectors, an underweight to consumer staples and an overweight to communication services contributed to performance.
On an individual stock basis, the leading absolute contributors were positions in Nvidia, Amazon, Broadcom, Meta Platforms and Microsoft. The primary detractors were Estee Lauder (EL), AbbVie (ABBV), Sea Limited (SE), ETSY and Nike (NKE).
Evan Bauman, Managing Director, Portfolio Manager
Peter Bourbeau, Managing Director, Portfolio Manager
Aram Green, Managing Director, Portfolio Manager
Margaret Vitrano, Managing Director, Portfolio Manager
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Past performance is no guarantee of future results. Copyright © 2023 ClearBridge Investments. All opinions and data included in this commentary are as of the publication date and are subject to change. The opinions and views expressed herein are of the author and may differ from other portfolio managers or the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This information should not be used as the sole basis to make any investment decision. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither ClearBridge Investments, LLC nor its information providers are responsible for any damages or losses arising from any use of this information. Performance source: Internal. Benchmark source: Russell Investments. Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and/or Russell ratings or underlying data and no party may rely on any Russell Indexes and/or Russell ratings and/or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. Performance source: Internal. Benchmark source: Standard & Poor’s. |
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
