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Aggressive Growth Strategy

Second Quarter 2018

Key Takeaways
  • Momentum stocks in mega cap technology and Internet continued to lead in the quarter but market breadth improved.
  • The portfolio’s energy and health care holdings were significant contributors as solid business fundamentals are becoming recognized.
  • We believe this year is playing out like 2000, where there is potential for a major inflection point in sector leadership.
Market Overview

U.S. equities delivered broad gains in the second quarter, with the best contributions coming from small cap and growth stocks. The Russell 2000 Index advanced 7.75%, the Russell 3000 Index returned 3.89% while the S&P 500 Index added 3.43%. The benchmark Russell 3000 Growth Index was up 5.87% for the quarter, outperforming its value counterpart by 416 basis points.

The momentum trade, bolstered in part by inflows into passive vehicles, resumed its position as a primary driver of stock performance. The Nasdaq 100, home to the largest information technology (IT) and Internet stocks, gained 10.1% during the second quarter. Yet, unlike the relatively narrow leadership in 2017, the positive performance extended beyond just the FAANG stocks. The S&P 500 Energy Index gained 13.5%, bolstered by a 14.2% rise in crude oil prices while the Nasdaq Biotechnology Index rose 7.1%.

Meanwhile, volatility trended closer to normal levels than it had in the past year. The heightening of U.S.-China trade tensions in mid to late June caused equities to pare gains, with some of the steepest declines occurring among the more momentum-driven segments of the market. While short-lived, this action illustrated the escalating risk present in the most expensive and crowded area of the market where there is little support for current valuations.

The portfolio’s lack of concept-oriented stocks trading at extreme multiples has been a drag on short-term relative results. We remain confident, however, in maintaining our IT exposure through companies with sound businesses and healthy balance sheets operating in areas less susceptible to competitive threats. We can still purchase these growth companies at attractive valuations. Twitter, for example, is a company we added to the portfolio when the stock was institutionally underowned and dramatically undervalued as the market was doubtful about its monetization strategy. Despite the stock’s strong recovery, it remains at a small fraction of the market cap of many of its peers, with the potential to continue to gain market share in its differentiated video business. Several other IT companies in the portfolio that have performed well this year, like Seagate Technology, Autodesk, and Cree, have transitioned their business models to areas like the cloud and electric vehicles where they see a sustainable competitive advantage. 


"M&A activity is one of the key catalysts we believe could hasten a change in market leadership."


Perhaps the most encouraging trend we witnessed in the quarter was a broadening of market leadership. Three sectors where trends are favorable for companies that we own are energy, health care and media. Within energy, stock prices of the exploration & production companies that trailed in a strong commodity rally in the second half of 2017 are now catching up. In this higher price environment, when there is greater incentive to ramp up drilling, companies like Anadarko Petroleum and Newfield Exploration are demonstrating good capital discipline, and in the case of Anadarko, returning capital to shareholders through increased buybacks, dividends and debt repayment.

One factor supporting U.S. crude prices – a bottleneck in transporting oil from storage in Cushing, Oklahoma – highlights the need to modernize oil infrastructure. Nearly four years of deferred capex by large producers has left oilfield equipment in need of upgrades and new drilling technologies. We expect a pickup in capex that should meaningfully benefit demand and pricing power for the service companies in the portfolio: Weatherford International, National Oilwell Varco and Core Laboratories. Given increasing global energy demand and OPEC’s consistency in sticking with its production targets, we believe the energy sector should remain strong.

Share buybacks are one of the metrics we monitor when assessing whether a company is attractively valued. During the second quarter, a number of our portfolio companies announced new buyback programs or increased existing ones. Three of these occurred in the health care sector, with UnitedHealth Group, Amgen, and Biogen sending signals that their shares were undervalued. We have been commenting about the distressed valuation levels of biotech companies for the last 18 months and as Exhibit 1 shows, industry multiples continue to lag both the health care sector and the overall market. We were encouraged in the second quarter as our biotech holdings began to re-rate higher. The pace of scientific breakthroughs like gene therapy and the development of new therapeutics for unmet needs like Alzheimer’s disease is steady, which should provide a long runway for these companies to appreciate.


Exhibit 1: Biotechnology Multiples Remain Depressed

U.S. Mature Biotech is an equal weighted group comprised of Amgen, Biogen, Celgene and Gilead Sciences. S&P 500 Healthcare is an equal weighted index of 61 health care companies. Source: Bloomberg as of June 30, 2018.


Merger & acquisition activity is one of the key catalysts we believe could hasten a change in market leadership, starting in the media sector. The June approval of the AT&T/Time Warner merger sends a positive signal for distributors looking to acquire programming assets to better compete with offerings from streaming media providers. In fact, we saw content companies like Discovery and AMC Networks start to re-rate higher following the announcement on the likelihood of more consolidation. We could see an uptick in deal making ahead of midterm elections while the regulatory environment remains supportive. M&A could also have an impact across the health care sector as large cap pharmaceutical companies look for new sources of growth.

We remain convinced that this year is shaping up like 2000, where, after a sharp and narrow dotcom led rally in the Nasdaq, performance shifted dramatically into a new set of companies and sectors. Across media, health care, and energy, the portfolio holds undervalued companies with strong free cash flow and characteristics attractive to competitors looking to add scale as well as activist and strategic investors. Having been through cycles like this before, we believe that there is increasing risk in certain crowded segments of the market while risk/reward remains excellent in others. As long-term business owners, we remain committed to helping our portfolio companies realize their value.

Portfolio Highlights

The ClearBridge Aggressive Growth Strategy outperformed its Russell 3000 Growth Index benchmark during the second quarter. On an absolute basis, the Strategy had gains in five of the eight sectors in which it was invested (out of 11 sectors total). The main contributors to performance were the health care and energy sectors while the main detractor was the industrials sector.

In relative terms, the Strategy outperformed its benchmark due to sector allocation. Stock selection in the energy and health care sectors, an overweight allocation to energy and an underweight to industrials contributed the most to relative results. Conversely, stock selection in the IT and consumer discretionary sectors hurt relative performance the most while an underweight to IT was also detrimental.

On an individual stock basis, the largest contributors to absolute returns included UnitedHealth Group, Anadarko Petroleum, Twitter, Core Laboratories and Biogen. The greatest detractors from absolute returns during the second quarter included positions in Western Digital, TE Connectivity, Comcast, Fluor and L3 Technologies.

During the second quarter, we sold out of small positions in Adient in the consumer discretionary sector, Mallinckrodt in the health care sector, Fitbit in the IT sector and Frank’s International in the energy sector.

Richard Freeman

Portfolio Manager
42 Years experience
35 Years at ClearBridge

Evan Bauman

Portfolio Manager
22 Years experience
22 Years at ClearBridge

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  • All opinions and data included in this commentary are as of June 30, 2018, and are subject to change. The opinions and views expressed herein are of the portfolio management team named above and may differ from other 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 nor its information providers are responsible for any damages or losses arising from any use of this information.

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  • Past performance is no guarantee of future results.