- Positioning changes implemented during the latest selloff proved beneficial as equities staged a powerful first-quarter rebound.
- Strength in consumer discretionary and health care companies drove results.
- We are closely monitoring potential regulatory and legislative developments in the technology and health care sectors as well as signs that we are entering the later stages of the economic cycle.
Growth stocks resumed their upward climb in the first quarter, rebounding from the late 2018 selloff to deliver the best start to a year in two decades. The S&P 500 Index advanced 13.65%, it’s best first-quarter showing since 1998, the Russell 1000 Index added 14.00% while the Russell Midcap Index rose 16.54%. The benchmark Russell 1000 Growth Index rallied 16.10%, outperforming its value counterpart by 417 basis points.
Equities are rallying again against a decidedly mixed economic backdrop. The Federal Reserve paused its rate tightening program during the quarter, satisfied that inflation is under control and that the current moderate pace of GDP growth can be maintained. Continued solid employment numbers and strengthening wage growth suggest the consumer is in good shape. But weaker manufacturing data and a yield curve inversion in March, coupled with the lack of resolution to trade negotiations between the U.S. and China, suggest business activity could slow going forward. Our portfolio companies are expressing growing caution with a general pause in activity.
The Large Cap Growth Strategy takes a diversified, long-term approach that seeks to promote a stable return stream across varying market and economic conditions and across growth companies targeting both consumer and enterprise spending. Our focus on a company’s growth prospects over a three to five-year time horizon provides opportunities to take advantage of short-term price dislocations to add to existing positions or establish new ones. Shares of Nvidia, which we added in the fourth quarter following the chip maker’s disappointing earnings results, rose more than 30% during the first quarter while Chinese e-commerce company Alibaba, a name we added to amidst 4Q selling pressure, also outperformed in the equity rebound.
Both stocks fall into our select growth bucket of companies generating high revenue and earnings growth from innovative business models that seek to disrupt existing markets or create new ones. Grubhub is our newest position in the select bucket and increases our exposure to consumer spending trends that we believe have staying power. Grubhub is the largest online and mobile food ordering and delivery company in the U.S. The company, which operates under multiple brands and platforms including Seamless and LevelUp, is a leader in a nascent market in online restaurant ordering for pickup and delivery that is growing steadily. Grubhub is currently in an investment cycle to gain presence in new markets, but margins should improve as spending tapers off in 2020 and order frequency increases. Expanding to smaller markets and increased competition pose risks but we believe the company is well positioned as long as customer acquisition costs hold steady.
One of the portfolio’s leading contributors in the first quarter also targets the consumer: Chipotle Mexican Grill. Chipotle falls into our cyclical bucket of companies facing near-term headwinds that we believe are fixable and should result in a step up in earnings growth. Chipotle is successfully working through reputational issues and product missteps and should see its earnings return to former highs over time, with greater store efficiencies, menu innovation, digital ordering and new loyalty program.
In addition to repositioning our consumer discretionary allocation, we were active during the quarter in trimming our health care exposure. Here we closed a position in biotechnology holding Celgene and drastically reduced our position in Regeneron Pharmaceuticals. Global drug maker Bristol-Myers Squibb announced in January its intentions to acquire Celgene at a more than 50% premium. Celgene had underperformed prior to the deal news as investors were concerned that its own recent acquisitions signaled a weaker pipeline, slowing revenue growth and earlier generic risk for its leading therapy, Revlimid.
Regeneron specializes in treatments for serious medical conditions including macular degeneration and atopic dermatitis. The stock has performed well and has been trading at the high end of our valuation range. The company’s Eylea eye treatment has significant exposure to Medicare Part B, which appears to be a governmental bullseye relating to prescribing incentives and rebates. Regeneron remains a leading, innovative biotech company with great financial partners and many molecules in early trials for PD-1 T-cell and gene therapy, but it also serves crowded markets.
We continue to evaluate our options for another biotechnology holding, Biogen, which sold off sharply after a surprise announcement that it was ending clinical trials for Alzheimer’s treatment aducanumab. We have always recognized the risks in the company’s pipeline and continue to see value in its Spinraza franchise, however the cancellation of Biogen’s Alzheimer’s program could negatively impact the stock’s long-term risk/reward profile. Offsetting weakness in Biogen, Alexion Pharmaceuticals was a solid performer thanks to the strong launch of its Ultomiris treatment for a rare blood disorder.
"Rather than try to time shifts in the economy, our focus remains on portfolio companies and sourcing new growth ideas."
Health care was a positive contributor for the quarter, boosted by Thermo Fisher Scientific, a company in the stable growth bucket of leading franchises with predictable earnings and cash flows. Thermo Fisher is a diversified global provider of products, services and research to the biotechnology, government, diagnostics and industrial markets. The company’s management team has successfully driven growth through accretive acquisitions.
Thermo Fisher is one of several multinational companies that have been seeing solid results in one of our areas of focus: China. Despite recent headlines about slowing industrial activity in the world’s second largest economy, we are encouraged by the aggressive stimulus measures being enacted and recent results from Alibaba, Yum China and Starbucks suggest the Chinese consumer is doing fine.
As the political season gears up, we are expecting policy comments within both information technology (IT) and health care that are more rhetoric than reality. These sectors represent the largest absolute exposures in the portfolio and we are keeping a close eye on factors in both. Recently announced government plans to reform rebates in Medicare Part D and drug payments in Medicare Part B as well as Congressional efforts to advance “Medicare for All” legislation could impact health plans, pharmacy benefit managers and distributors. In addition, we are monitoring health care inflation and the potential for pricing controls on pharmaceutical and biotech treatments. Within technology, several of our portfolio companies with significant Internet businesses could be subject to increased regulation over data usage and privacy.
The current U.S. economic expansion is showing signs of age. Rather than try to time shifts in the economy, our focus remains on portfolio companies and sourcing new growth ideas through bottom-up fundamental research. A balanced approach to portfolio construction, characterized by the three buckets of growth companies detailed above, helps promote consistent long-term results. This perspective allows us to be more active buyers during periods of price dislocation.
In a momentum market led by the very largest IT and Internet stocks, like the one experienced in the first quarter and for most of the last several years, our balanced approach may not always keep pace. The ClearBridge Large Cap Growth Strategy slightly underperformed its Russell 1000 Growth Index benchmark during the first quarter. On an absolute basis, the Strategy had gains across all 10 sectors in which it was invested (out of 11 sectors total). The primary contributors to performance were the IT and consumer discretionary sectors.
On a relative basis, overall stock selection contributed to performance but was offset by negative sector allocation effects. Specifically, stock selection in the IT sector was the primary detractor from relative returns. Stock selection in the industrials and financials sectors and the Strategy’s cash position also had a negative impact. On the positive side, stock selection in the consumer discretionary, health care and consumer staples sectors drove relative performance.
On an individual stock basis, leading individual contributors to absolute returns in the first quarter included positions in Amazon.com, Facebook, Chipotle Mexican Grill, Celgene and Microsoft. Biogen, Grubhub, Nutanix, Qualcomm and Coca-Cola were the biggest detractors.
During the first quarter, the Strategy initiated new positions in Grubhub and Advance Auto Parts in the consumer discretionary sector and closed a position in Celgene in the health care sector.