Commentary

Key Takeaways

• Markets are discounting a high probability that President-elect Trump’s pro-growth policies will be successful in jumpstarting the U.S. economy.
• Strength in financials and health care stocks drove portfolio performance.
• We are taking a wait and see approach until the specifics of Trump’s proposals and their likelihood of passage become more definitive.

Market Overview and Outlook

A decidedly positive reaction to the presidential election of Donald Trump lifted U.S. markets to broad gains for the fourth quarter and the year. The S&P 500 Index gained 3.82% for the quarter and 11.96% for the year, the Russell 1000 Index advanced 3.83% for the quarter and 12.05% for the year while the Russell Midcap Index added 3.21% for the quarter and 13.80% for the year. Growth stocks lagged value stocks with the benchmark Russell 1000 Growth Index (+1.01% for the quarter) underperforming its value counterpart by 567 basis points for the quarter and 1025 bps for the year.

Equity markets are betting that Trump’s pro-growth policies will be successful in jumpstarting a U.S. economy that has been mired in a tepid expansion since the financial crisis. This optimism is based on the President-elect’s proposals for tax cuts and reforms, increased fiscal spending and the likelihood of looser government regulation of corporations and corporate activity such as mergers & acquisitions. The Federal Reserve affirmed this more optimistic outlook for the economy by raising interest rates in December and upping its planned pace of tightening over the next year.

Financial, managed care and industrial companies are expected to be the biggest near-term beneficiaries under the Trump administration. Lower costs related to regulation and higher interest rates propelled portfolio companies Charles Schwab and American Express to robust post-election gains. The potential repeal or reform of the Affordable Care Act boosted managed care providers including UnitedHealth Group while hopes of less stringent deal review lifted the prospects of portfolio holding Aetna completing its acquisition of Humana. Industrials meanwhile, were the top performing sector in the index, boosted by the prospects for increased infrastructure spending. Our underweight to the sector was a performance headwind for the quarter.

Beyond the election, OPEC’s decision to pare back production caused oil prices to rise 11% for the quarter, benefiting the energy sector. We are optimistic that the oil market will continue to recover as global supply and demand come into balance. In the technology sector, many companies are experiencing a slowdown in spending by corporate clients, with some of the largest cuts coming in the information security area. After a flurry of reactionary spending to high profile data breaches over the last 18 months, companies are now rethinking their approach to security. This pause could last several more quarters, but we believe the long-term demand for security solutions from portfolio companies Palo Alto Networks and Fortinet remains strong.

"Financial, managed care and industrial companies are expected to be the biggest near-term beneficiaries under the Trump administration."

Higher interest rates continued to prop up the U.S. dollar, which climbed to its highest levels against global currencies since 2002. A stronger dollar has been a headwind for the last several years and that could continue in the near term. The trajectory of dollar appreciation in 2017 could be influenced by tax policy, specifically border adjustments for imports. We do not expect the portfolio will be overly impacted by dollar strength as the overseas revenues of the companies we own are mostly in line with our benchmark.

As communicated in past commentaries, we have positioned the portfolio for a low growth environment and will need to gain more confidence in the prospects for improved growth before making major changes. The substance of Trump’s proposals is still largely unknown and the President-elect’s success in getting his full agenda through Congress is far from assured. The first half of 2017 should engender further uncertainty as those proposals enter the policymaking stage. We will be closely evaluating this process and determining where it makes sense to reposition our portfolio exposures to capture attractive growth opportunities.

Portfolio Highlights

The Large Cap Growth Strategy outperformed its Russell 1000 Growth Index benchmark during the fourth quarter. On an absolute basis, the Strategy had gains in six of the sectors in which it was invested during the fourth quarter (out of eight sectors total). The primary contributors to the Strategy's performance were the financials and industrials sectors while the primary detractor was the consumer staples sector.

In relative terms, Strategy performance was driven by stock selection. In particular, stock selection in the health care, financials and energy sectors, an overweight in financials and a lack of exposure to the real estate sector were the primary contributors to performance during the period. Meanwhile, stock selection in the consumer staples and information technology (IT) sectors, an underweight to the industrials sector and an overweight to health care hurt relative performance the most.

On an individual stock basis, Akamai Technologies in the IT sector, Charles Schwab in the financials sector, UnitedHealth Group and Celgene in the health care sector and Walt Disney in the consumer discretionary sector were the largest contributors to absolute performance during the fourth quarter. Amazon.com in the consumer discretionary sector, Anheuser-Busch InBev and CVS Health in the consumer staples sector as well as Palo Alto Networks and Red Hat in the IT sector were the greatest detractors from absolute returns.

During the fourth quarter, we initiated positions in Dentsply Sirona in the health care sector and Chipotle Mexican Grill in the consumer discretionary sector and closed a position in Bristol-Myers Squibb in the health care sector. We also sold our position in Yum! Brands in the consumer discretionary sector, replacing it with Yum China Holdings Inc., which was spun out of Yum! in November.

The merger of Dentsply International and Sirona Dental Systems has created the industry leader in the dental supplies and equipment space with a one-third share of the market. The company is a consistent executor that should be a prime beneficiary of a secular trend in technology adoption by dentists. We also see margin upside for the stock. Chipotle has lost more than half its value following food quality issues in 2015 and recent customer service struggles. The burrito chain faces easier comps in the near term and we believe the company is taking the necessary steps to rebuild its core customer base which include the launch of a mobile ordering and pick up option.

Shares of Bristol-Myers sold off following a failed clinical trial for its Opdivo treatment for lung cancer. We believe the company became too concentrated in a limited number of treatment areas and designed a poor trial that has caused it to cede market share to competitors. Sale proceeds were put to work in better opportunities across our existing holdings.