Market Sector Update
- Market returns as measured by the S&P 500 Index, the Fund’s benchmark, have been very moderate over the past quarter. While a period that was pretty unexciting from a return stand point, there was significant volatility versus recent history.
- The bull market for U.S. stocks, which reached seven years on March 9, had proceeded without much of a pause until the first 10% pullback in August 2015. This pullback was primarily centered on a significant economic growth slowdown in China and the potential ramifications if the country were to devalue its currency. Then, after a strong 4Q market rebound in 2015, macro-related concerns resurfaced at the start of 2016.
- Within a small gain for the quarter, there was some significant divergence between sectors. The more defensive sectors of the market, utilities, telecommunications and consumer staples, all posted double-digit returns.
- The biggest surprise from a sector standpoint was the negative performance of health care. This sector would typically perform more in line with the defensive areas of the market; however, it was put under significant pressure over the past six months due to election uncertainty.
- The Fund underperformed its benchmark for the period ended March 31, 2016. The combination of the Fund’s overweight in health care and underweight in telecommunications and utilities was the primary cause of relative underperformance in the quarter.
- Many health care companies are in the process of completing large merger and acquisition (M&A) transactions, which have pressured these stocks due regulatory uncertainty more than the group as a whole. Much like the health care related political uncertainty due to the upcoming election, we believe the issues around M&A will be resolved in the next few quarters and the stocks will perform materially better than they have over the past several months.
- Utilities and telecommunications are historically expensive versus their tepid earnings growth. While higher dividendpaying stocks remain in favor with interest rates low, we don’t think continued outperformance of these stocks that have little to no earnings growth is sustainable.
- Other moves in the portfolio included a continued increase in the energy weighting, with the high-conviction belief that current oil prices will result in falling production over the next year. We think the world will need the U.S. to resume oil production growth at some point in 2017, benefiting both high-quality exploration and production companies as well as oil service companies. Holdings such as EOG, Cimarex, and Haliburton would likely benefit from this development
- Despite the recent underperformance, our longer-term macroeconomic outlook has not changed. Slower-than-desired economic growth should continue to keep interest rates low and favor a more defensive positioning for the Fund overall.
- Our sector overweight positions in consumer staples and health care are likely to remain in place. We expect companies to continue to look for attractive acquisition opportunities as a way to increase earnings power through cost and revenue synergies. Another symptom of continued slow growth so late in the recovery is the increased frequency of predictions that the U.S. economy is headed back into recession. We expect these negative views to result in increased volatility like we saw in 1Q2016.
- Most importantly, we firmly believe that over a multi-year period, stocks will follow investor expectations for long-term earnings power. We continue to implement this belief by owning companies that we think have strong and improving competitive positions as well as underappreciated multi-year earnings catalysts. This belief is fundamental to our philosophy and has served us well over the past decade.
*Top 10 holdings (%) as of 03/31/2016: Philip Morris International 4.1, Microsoft Corp, 4.0, Alphabet, Inc. 3.7, Teva Pharmaceuticals Industries 3.2, Applied Materials 3.1, American Tower Corp. 3.0, Kraft Food Group 2.9, NXP Semiconductors 2.8, American International Group 2.7 and Shire Pharmaceuticals Group 2.7.
The opinions expressed in this commentary are those of the Fund’s managers and are current through March 31, 2016. The managers' views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. Past performance is not a guarantee of future results.
The S&P 500 Index is composed of 500 selected common stocks chosen for market size, liquidity, and industry grouping, among other factors. It is not possible to invest directly in an index.
Risk factors. The value of the Fund’s shares will change, and you could lose money on your investment. Because the Fund is generally invested in a small number of stocks, the performance of any one security held by the Fund will have a greater impact than if the Fund were invested in a larger number of securities. Although larger companies tend to be less volatile than companies with smaller market capitalizations, returns on investments in securities of large capitalization companies could trail the returns on investments in securities of smaller companies. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.
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