Q4 2018 Commentary
- For Q4 2018, the Fund returned -10.0% vs. S&P 500 Total Return Index ($CDN) which retuned -8.7%.
- During a volatile three-month period ending December 31, 2018, the strategy had a negative return and slightly underperformed the S&P 500 Index. Stock selection and sector allocation both drove relative underperformance. Positions within real estate, industrials and consumer staples contributed to performance. Selections within consumer discretionary and communication services hurt most.
Contributors to Performance
- Within health care, our position in Danaher proved beneficial to performance. Danaher reported a very strong set of third-quarter results and raised guidance, this helped the stock rise despite the volatile market backdrop. Danaher reported overall core revenue growth of 6.5%, primarily driven by the life sciences and environmental & applied solutions segments posting high single digit growth. Danaher's dental segment, which will be spun off next year, disappointed. Danaher also benefited from a search for sustainable growth during the quarter, as roughly 65% of its revenue from consumable sales, which historically hold up better in a downturn. Within information technology, our overweight to PayPal and Visa proved favorable to results. An overweight to American Tower Corp (real estate) also boosted relative returns.
Detractors from Performance
- Within consumer discretionary, our exposure to Amazon hurt most. Despite a 29% increase in net sales, year over year, Amazon stock declined during the quarter, as its AWS (cloud business) revenue growth slightly decelerated and the company's guidance for the next quarter was weaker than expected. A meaningful overweight to Activision Blizzard led the communication services sector to detract. Other top detractors included our positions in Apple, RealPage and Procter & Gamble Company.
- Portfolio Activity
- We initiated a position in Lonza Group AG.
- We eliminated our positions in Wynn Resorts Ltd., BlackRock Inc., Alexion Pharmaceuticals Inc. and Proofpoint Inc.
- S. stocks ended the year with a bruising quarter, and all three major indexes notched their worst annual performance in a decade. The impact of escalating trade tensions between the United States and China, concerns about a global economic slowdown, and political uncertainty fueled market volatility during the quarter. U.S. equities were lifted following the mid-term congressional elections, but struggled amid concerns about government gridlock later in the quarter. Economic data was generally positive, although the trade deficit continued to widen, import prices increased, and consumer sentiment weakened. Worries about excess oil supply and slowing global growth caused volatility in the energy market. The spread between the two- and 10-year Treasury yields narrowed the most since 2007, fueling fear that the flattening yield curve may be signaling a recession.
- As far as 2019 outlook, we remain reasonably balanced. The market has shifted from a narrative of synchronized global growth to a more somber tone in in the second half of 2018, and there's no denying that late-cycle market indicators are emerging. Areas of the market such as automobiles and housing are decelerating while profit margins across the market are at or near record highs. Additionally, inflationary forces are starting to appear (e.g., labor shortages in trucking), and there are some meaningful regulatory risks specifically around mega-cap tech (e.g., data privacy). The negotiations around tariffs and trade also introduce uncertainty and the ability to pass on raw material inflation to end-customers is going to be critical. The portfolio's emphasis on pricing power synchs up well for this unique challenge.
- There are offsets to the headwinds mentioned above however, which suggest an imminent recession is unlikely. GDP remains above 2% domestically; corporate tax rates are now globally competitive, having moved meaningfully lower with incentives for capital spend; unemployment remains historically low with signs of wage growth; central banks seem to be taking a less hawkish stance and largely maintaining accommodative policy; and there is significant evidence of falling regulations in multiple sectors. Based on consensus 2019 estimates, S&P 500 earnings are expected to grow at a healthy rate, which is supportive for continued market returns.
- The net effect of these confluent forces is likely a broadening out of leadership across sectors rather than a repeat of FAANG-lead market performance in 2017 and 1H18. Within areas such as health care, we've searched for companies that manufacture and distribute high-value, low ASP products essential to enhancing patient outcomes. We've also identified some longer duration, high-return growth ideas within consumer discretionary while applying our thematic overlay.
- All in, it's difficult to accurately predict some of the most important market-driving variables heading into 2019 such as the exact pace of Federal Reserve action or the timing and details of a trade agreement with China. At a high level, our stance remains modestly positive though, and there should be plenty of opportunities within the market over the next twelve months. The portfolio will continue to apply a top-down thematic lens coupled with an emphasis on the growth level and duration of our owned businesses, the capital return profile, and making sure there's an ownership culture present. These criteria when applied rigorously and continuously should yield favorable results in a variety of economic backdrops.
PORTFOLIO MANAGEMENT TEAM:
Putnam Investments Inc.: Richard E. Bodzy, MBA