Bet_Noire
Pivoting to Areas of Visible Growth
Market Overview
Stocks entered a bear market in the second quarter as inflation intensified and corresponding aggressive actions from the Federal Reserve weighed on corporate results and investor sentiment. Continued price pressures and disruptions in the global supply chain from the beginning of the year were met by rising fears of recession and knocked down the benchmark Russell 3000 Index by 16.70% for the quarter, ending the worst start. of the year for equities since 1970.
Rising interest rates continue to weigh heavily on higher many and smaller growth cap stocks, whose earnings are discounted sharply in the future, with the small and mid cap focused on The Russell 2500 Growth Index was down 19.55% for the quarter while the Russell Midcap Growth Index was down 21.07%. Growth has led in value over the past three and six months, with the spread between investment styles being the widest in history.
In addition to a lot of compression and a flight towards the relative safety of large caps, the ClearBridge Select Strategy has exposure to areas that weakened after increasing demand during the pandemic, including consumer technology and e-commerce. For the quarter, the consumer discretionary (-25.73%) and information technology (IT, -21.37%) sectors, which represent two of the Strategy’s key exposures, performed the worst on the benchmark. Sectors that hold better, including consumer staples (-4.96%), utilities (-5.18%). and energy (-5.99%), together represent a smaller, weighing in Strategy. Health care (-7.34%) also exceeded but our smaller cap orientation decreased.
As a result, Strategy failed to set the benchmark for the second quarter. Given the rapidly changing dynamics in the economy, we have made some important changes in strategy and are willing to wait for what we expect to be a volatile period to maintain exposure to stocks that we think will prove to be long-term compelling. investment.
Our investment philosophy is to lean on growth, own companies that control their own fortunes, capture market and mind share and are attracted to secular tailwinds such as increasing efficiency and implementing decisions based on data. At the same time, we tactically pivote the portfolio to favor companies with less risk in near-term earnings and earnings counts. Monster Beverage (MNST) and Constellation Brands (STZ), two beverage manufacturers we added at great prices in 2021, are examples of the constant compounder that has succeeded well in falling equity.
Portfolio Positioning
Among our fast -paced holdings, the higher -growth portion of the portfolio featuring companies with highly innovative business models, we reduced our exposure to consumer -facing businesses and moved toward software. Activity in the quarter was highlighted by the sale of online used car retailer Carvana (CVNA) and e-commerce software maker VTEX (VTEX) in favor of adding Snowflake (SNOW), a cloud-based data platform that is a primary beneficiary of data analytics and cloud migration. The purchases of Everbridge (EVBG) (critical response) and LivePerson (LPSN) (customer service) provide exposure to the catalyst -rich software companies we have long followed, each with a growing activist presence driving for the improvement and potential sale of the business. We also added to the current positions ServiceNow (NOW) (workflow software), SentinelOne (S) (cybersecurity), GitLab (GTLB) (developer operations) and PayCor (PYCR) (payroll and talent management).
Healthcare is another sector where innovation allows companies to engage with existing players or create new markets. The new addition Doximity (DOCS) operates the largest professional social network for physicians, with a long runway for growth within its core market for medical professional marketing, procurement, and telehealth solutions. Progyny (PGNY) is a leading provider of fertility benefit management services to self-insured employers. The company is underpenetrated in its overall addressable market and has logical adjacencies (labs/diagnostics, return to work support) and demographic tailwinds (starting families later leads to higher infertility risk) that should provide- allow it to maintain high top-line growth. Both companies are growing above the industry average while increasingly profitable.
Energy has proven to be a recent source of new ideas. Here, we target emerging opportunities, companies with specific drivers towards running trade enhancements at low costs. Pioneer Natural Resources (PXD) fits that narrative in 2020 when we made the oil exploration and production company core holding. Intra-quarter, it grew to the largest holding in Strategy. We then cut Pioneer to reduce our direct oil exposure and rotated to natural gas with new positions at leading producer Chesapeake Energy (CHK) and drilling, services and technology supplier Baker Hughes (BKR). Energy remains one of the tighter commodity markets on the supply side and is experiencing a change at sea since Russia’s departure from the market. Europe will become more dependent on US natural gas, which can be sold more profitably there than domestically.
Pressure on equities has created new opportunities to put excess money to work. As prices dropped, we reduced our currency position from 9% at the beginning of the season to approximately 2% at the end. In addition to the activity previously mentioned, we cut several industrial positions while adding in steady compounders including car auction operator Copart (CPRT).
Exhibit 1: Valuations Support Small and Medium Cap Stocks
Data as of June 30, 2022. Source: FactSet, Standard & Poor’s.
Outlook
The second quarter saw investors move from a fear of owning growth stocks to a broader fear of an impending recession. As risks have changed, negative effects continue to be most acute in small cap stocks (Exhibit 1). High recession concerns have gained momentum from recent performers such as commodities, as more growth-oriented market segments are seeing improvement. We believe this speaks to the long -term potential of alpha generation from taking an unlimited approach that does not rely on mega caps.
Given the pressures facing the global economy – inflation exacerbated by the war in Ukraine, a slowdown in China, strength of the dollar – we think it makes sense to invest closer to home and expect a round of leadership back to small caps based in the US. Despite liquidity restrictions, change is not slowing down and we continue to use it by investing in companies with stronger balances that offer unique products and services. We believe that such leaders will be stronger emerging from this challenging environment. Competing against young upstarts who are hungry for money, established growth franchises should be easier to hire, gain customers and innovate at their own pace and scale. This philosophy has benefited our performance in the release of earlier bear markets, and we expect to use the same playbook this time around.
Portfolio Highlights
ClearBridge Select Strategy failed to hit its benchmark in the second quarter. On an absolute basis, Strategy posted losses in nine of the 10 sectors in which it invested (out of a total of 11 sectors). The sole contributor was the consumer staples sector while the main detractors in performance were in the IT, consumer discretionary, industrial and health care sectors.
In relation to the benchmark, overall stock selection is reduced in performance. In particular, stock selection in the IT, healthcare and consumer discretionary sectors is hurting the results. On the positive side, stock selection in consumer staples and the financial sector, overweight in consumer staples and underweight in communication services contributed to the performance.
On an individual stock basis, the top contributors are positions in Monster Beverage, Gitlab, Doximity, Global-e Online (GLBE) and Carvana. The main detractors are Expedia (EXPE), MercadoLibre (MELI), Surgery Partners (SGRY), Workday (WDAY) and Apple (AAPL).
In addition to the transactions mentioned above, we initiated a position in Global-e Online in the consumer discretionary sector and sold a position in Definitive Healthcare (DH) in the healthcare sector.
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Editor’s Note: The summary bullets for this article were chosen by the editors of Seeking Alpha.