- Strong performance of health care and industrials companies suggests a rotation in market leadership could continue.
- Increased capital spending in the energy sector should prove beneficial to oil services companies as well as disciplined drillers.
- Weakness among several technology names weighed on results.
After making only modest gains in June, U.S. equities rose more rapidly in July as positive economic data and strong corporate earnings outweighed investor anxieties over escalating tariffs. The S&P 500 Index gained 3.72% for the month, the Russell 3000 Index added 3.32% while the small cap Russell 2000 Index edged 1.74% higher. The benchmark Russell 3000 Growth Index gained 2.84% for the month, trailing its value counterpart by 95 basis points in a rare winning month for value stocks.
We have been noting incipient signs of a shift in market leadership from momentum-driven mega cap technology and Internet names and July’s results provide further evidence that a rotation may be underway. The information technology (IT) sector (+2.01%) trailed the benchmark for the month, with industrials (+6.68%) and health care (+4.53%) leading performance.
Health care, specifically our biopharmaceutical holdings, had been under pressure for some time, but the rallies we’ve seen this year from extraordinarily low valuation levels continued in July. Shares of Allergan, which traded at less than nine times earnings earlier in the year, are up nearly 30% since several activist owners took stakes in the company. Allergan, the maker of Botox, had a beat and raise quarter, announced a $2 billion share buyback and has recently reported some very positive clinical results. Long time biotechnology holding Amgen also had a beat and raise quarter while Biogen reported positive trial results on an Alzheimer’s treatment it is developing with Japan’s Eisai. The trial furthered the premise that targeting the buildup of plaque in the brain can improve cognition, which is consistent with the goal of Biogen’s other Alzheimer’s treatment in the pipeline.
Several of our largest IT holdings were down sharply during the month, but we remain confident in their execution and the large market opportunities they are targeting. Twitter posted what the consensus viewed as disappointing second-quarter results after several very strong quarters. We believe the stock suffered from expectations being too high as the company delivered solid numbers, notably accelerating video and overall revenue as well as daily average user growth. Monthly active users were down, but that was (at least) partially related to the cleaning up of its user base.
"We remain confident in the execution of our IT holdings and the large market opportunities they are targeting."
Broadcom, a major chip supplier to Apple, sold off on negative reaction to its proposed acquisition of software supplier CA Technologies. Despite the market’s skepticism, we view the deal as consistent with previous accretive deals management has executed. In a number of cases, Broadcom has acquired franchises with a high degree of recurring revenue with strong cash generation. In the CA acquisition, the mainframe software business generates half of the revenue and 90% of the cash flow of the combined company with 60%+ operating margins. We would not be surprised if Broadcom kept the part of the business with sticky, recurring revenue and ultimately divested some of the other businesses and put the cash flow to shareholder-friendly uses.
Energy gave back some of its recent gains during the month as crude oil prices retrenched 7%. Prices fell after news Libya would resume export activities at some ports and amid growing concerns a trade war would slow global economic growth and dampen demand for oil. Another fear among investors is the recent firming of commodity prices will spark a big pick up in spending by exploration & production companies. We expect Anadarko Petroleum, our largest energy holding, will remain disciplined in this environment, balancing capex by returning free cash flow to shareholders through buybacks, dividend raises and debt reduction. We think a positive outcome from increased capex will be an uptake in the business of oil services companies.
Better results from health care, a rebound in media names like Comcast and a steadying of the energy space illustrate the broadening of market performance that we believe is healthy and necessary after a long run for the momentum trade. We are starting to see different equity leadership, a pattern we have observed on the back end of previously crowded markets.
The ClearBridge Aggressive Growth Strategy underperformed its Russell 3000 Growth Index benchmark for the month of July. 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 primary contributor to performance was the health care sector while the IT sector was the chief detractor.
Relative to the benchmark, overall stock selection and sector allocation detracted from performance. In particular, stock selection in the IT sector weighed the most on relative results. An overweight to the energy sector and an underweight to the industrials sector also hurt returns. On the positive side, stock selection in the health care, consumer discretionary and industrials sectors and an overweight to health care contributed the most to relative returns.
On an individual stock basis, positions in Biogen, Comcast, Allergan, L3 Technologies and Amgen were the greatest contributors to absolute returns during the month. The largest detractors included Twitter, Core Laboratories, Broadcom, Seagate Technology and Western Digital.