Commentary

Key Takeaways

• Continued crowding into popular sectors including mega-cap tech and Internet names drove market performance during the month.
• Our active overweights to the health care and energy sectors weighed on relative performance during May.
• Despite equity indexes making new highs, the portfolio maintains a valuation discount to the market.

Market Overview and Outlook

Stocks recovered from a mid-month sell-off to finish mostly higher in May. The S&P 500 Index gained 1.41%, the Russell Midcap Index advanced 0.91% while the Russell 3000 Index added 1.02%. Growth stocks outperformed value stocks for the third straight month with the Russell 3000 Growth Index gaining 2.34% compared to a 0.34% loss for the Russell 3000 Value Index.

The May 17 appointment of a special counsel to investigate President Trump’s ties to Russia sparked the year’s biggest sell-off for stocks, with the S&P 500 declining 1.8%. Markets quickly rebounded with both the S&P 500 and the NASDAQ Composite (up 2.7% for the month) finishing May at all-time highs. Volatility, which spiked nearly 50% following the announcement of the investigation, quickly retreated, with the CBOE Volatility Index touching a decade low late in the month.

Information technology (IT) was the best performing sector in the Russell 3000 Growth benchmark, rising 5.31%. Investors have returned to mega cap tech stocks as optimism about Trump’s pro-growth agenda of tax cuts, deregulation and fiscal spending has waned. We continue to believe parts of the IT, Internet and consumer sectors are becoming over-owned, and rising complacency in these sectors is becoming apparent as strong passive flows have helped to push up prices and, in some cases, valuations. By comparison, we have a number of tech names in our portfolio trading at large discounts to the sector and the overall market, such as storage companies Western Digital and Seagate Technology as well as communications chip provider Broadcom. 

"Despite major indexes continuing to set all-time highs, certain sectors and subsectors remain attractively valued relative to growth."

Sluggish commodity prices were a drag on results as crude oil fell another 2% during May to $48.32 per barrel, despite OPEC and non-OPEC oil-producing countries agreeing to extend production cuts for an additional nine months. Energy was the worst performer in the benchmark with a loss of 6.03%. Crude oil has remained largely range-bound for the last year (with WTI crude trading between $40 and $55 per barrel), increasing the importance of owning companies that can generate strong returns and cash flows in this environment. As with other parts of the portfolio, many of our energy holdings remain at attractive valuation levels; and have undergone balance sheet improvements through asset sales and debt reductions. We believe that both production companies like Anadarko Petroleum and select service and drilling companies we own are well positioned to take share through a transition period for the sector.

Despite the major indexes continuing to set all-time highs, there are certain sectors and subsectors that remain attractively valued relative to growth.  As a whole, the portfolio maintains a significant valuation discount to the market, which is especially evident in the shares of certain innovative health care therapeutics companies. Certain portfolio holdings like Allergan and Biogen, whose shares traded lower during the month, are at multiples lower than the S&P 500 despite meaningful long-term growth rates. This makes us optimistic about the risk/reward potential in the companies we own, a confidence that is borne out by management teams that are taking advantage of these price discrepancies with share buybacks and continued spending on R&D to find treatments for large unmet medical needs. As long-term business owners, we continue to position the portfolio toward great companies with solid outlooks and strong balance sheets.

Portfolio Highlights

The Aggressive Growth Strategy underperformed its Russell 3000 Growth Index benchmark in May. On an absolute basis, the primary contributors to monthly performance came from the information technology (IT) sector while the primary detractors were in the health care and energy sectors.

Relative to the benchmark, overall stock selection and sector allocation detracted from performance. In particular, overweights to the energy and health care sectors and stock selection within those sectors had the greatest negative impact on results for the month. Stock selection in the consumer discretionary sector and an underweight to IT also hurt performance. Meanwhile, stock selection in the IT sector was the primary contributor to relative performance.

In terms of individual holdings, the leading contributors to monthly performance included positions in Autodesk, Broadcom and Seagate Technology in the IT sector, Vertex Pharmaceuticals in the health care sector and Comcast in the consumer discretionary sector. The leading detractors from performance included positions in Biogen, Allergan and Amgen in the health care sector as well as Anadarko Petroleum and Core Labs in the energy sector.