- The Federal Reserve followed through with its first interest rate cut in more than a decade, boosting the existing leadership of mega cap technology and Internet stocks.
- Economic growth and political concerns weighed on the energy and health care sectors, two areas where we maintain significant exposure and remain bullish long term.
- The valuation of the portfolio remains at a historical discount to our benchmark, creating what we consider a very attractive risk/reward outlook going forward.
Market Overview and Outlook
The U.S. equity market notched another month of gains in July, driven by expectations of an interest rate cut and positive corporate earnings reports. The S&P 500 Index rose 1.44%, the Russell 3000 Index added 1.49% while the small cap Russell 2000 Index gained 0.58%. The benchmark Russell 3000 Growth Index outpaced its value counterpart, advancing 2.17%, 139 basis points above the Russell 3000 Value Index.
Mega cap information technology (IT, +3.40%) and Internet stocks in the communications services sector (+4.84%) once again outperformed as monetary policy around the world took an accommodative turn. The portfolio saw positive results from its IT holdings, most notably Twitter, which delivered strong gains due to accelerating revenue growth, better engagement with its user base and increasing traction with content providers. Digital storage provider Western Digital was also a solid performer as memory prices appear to be bottoming with a positive inflection in pricing trends expected later this year or in early 2020.
Taking a precautionary stance amid low inflation, weak global growth and trade uncertainty, the Federal Reserve cut short-term interest rates for the first time in more than a decade, reducing the federal funds rate by 25 basis points. Likewise, the European Central Bank indicated its willingness to lower its key interest rates and raised the possibility of reintroducing its quantitative easing program.
Despite these actions, the risks to global growth and political rhetoric heading into the 2020 presidential election weighed on two sectors where the portfolio maintains meaningful overweights: health care and energy.
"We are in the early stages of sentiment starting to swing back toward undervalued growth areas."
Government policy and politics continue to pose uncertainty for managed care and biopharmaceutical companies. The Trump administration chose not to implement proposed changes to rebating rules in the Medicare Part D drug benefit in July, but investors’ concerns remain about possible adverse changes in drug pricing in Medicare. Additionally, Democratic presidential candidates continue to debate material changes to the U.S. healthcare system, although we think their implementation is unlikely. This negative sentiment was offset by robust earnings and clinical results from biotechnology holdings Biogen, Amgen and Vertex Pharmaceuticals. Shares of Vertex, in particular, retraced their July losses and moved higher in early August after raising revenue guidance for the year. UnitedHealth Group also delivered solid financial performance on operational strength across its managed care business.
On another positive note, large scale merger & acquisition activity continued in July, with Pfizer announcing the spinoff of its Upjohn off-patent drug business and Upjohn’s merger with generics company Mylan. Although we do not hold either stock, the need to show growth and the availability of inexpensive debt financing could drive further consolidation as a means of realizing the value of under owned biotechnology companies making scientific breakthroughs in the treatment of rare diseases and other conditions with no current therapies.
Oil prices breached the $60 mark for WTI crude on supply disruptions in the Gulf of Mexico, lower U.S. crude inventories and worries over an escalation of tensions between the U.S. and Iran but finished largely flat for the month at $58.58 amid concerns of softening demand and trade tensions. Canadian exploration & production company Encana was a leading detractor as the market remains concerned about how it will manage an increasing debt load from its acquisition of Newfield Exploration earlier this year.
We cannot remember a time where the valuation of the portfolio, compared to the market was as relatively attractive as today. Such a backdrop will not guarantee that the portfolio will outperform, but we are at a point where we believe the risk reward is significantly in our favor. Between M&A activity that is monetizing underappreciated assets to improving market breadth, we are in the early stages of sentiment starting to swing back toward undervalued growth areas. Through what has been a very powerful momentum trade, we have remained consistent to our discipline that has led to long-term value creation.
The ClearBridge Aggressive Growth Strategy underperformed its Russell 3000 Growth Index benchmark in July. On an absolute basis, the Strategy had gains across six of the eight sectors in which it was invested (out of 11 sectors total). The primary contributor to performance was the communication services sector.
Relative to the benchmark, overall stock selection and sector allocation detracted from performance. In particular, stock selection in the communication services and IT sectors and overweight allocations to health care and energy hurt relative results the most. On the positive side, stock selection in the energy and industrials sectors as well as an overweight to communication services and an underweight to the consumer discretionary sector aided performance.
On an individual stock basis, positions in Twitter, Cree, L3Harris Technologies, Comcast and Western Digital were the greatest contributors to absolute returns during the month. The largest detractors included Vertex Pharmaceuticals, Allergan, Autodesk, TE Connectivity and Encana.
During the month, we closed positions in Aduro BioTech in the health care sector, Liberty Latin America in the communication services sector and Liberty Expedia Holdings in the consumer discretionary sector. We also gained shares in L3Harris Technologies following the closing of the merger between portfolio holding L3 Technologies and Harris Corp.