Value Opportunities

Market Commentary

Period ended June 30, 2018
 

MARKET COMMENTARY

After a small decline in the first quarter of 2018, the S&P 500 Index returned +3.4% in the second quarter and is now up +2.7% for the year.  Strong corporate earnings prevailed over trade war risks and geopolitical tensions.  S&P 500 earnings grew an impressive +20% year-over-year in the most recently reported quarter, with more than 81% of companies beating consensus estimates.  More than 100 of the ~500 companies in the index reported earnings growth of more than 50% from a year ago.  Interestingly, the composition of this fastest-growing cohort was broadly distributed across sectors even though stock performance across sectors has varied significantly.  Going forward, consensus expectations are for earnings growth in the high teens, even with the looming threat of a global trade war. 

The Russell 3000 Growth Index returned +5.9% during the quarter, compared to +1.7% for the Russell 3000 Value Index.  The Russell 3000 Growth has outperformed its value counterpart in 14 of the past 20 quarters, including each of the past six.  A large part of the performance difference this quarter stems from significant variations in sector performance.  Energy, consumer discretionary, and technology were the best performing sectors, in that order. While energy is overrepresented in the value index, technology and consumer discretionary are much larger constituents in the growth index.   In addition, the financial sector, among the worst performing sectors in the quarter with a negative quarterly return, is much larger in the value index; financials represent 29.6% of the value index versus just 3.7% of the growth index.  Further, within sectors, growth outperformed value.  This was most pronounced in technology, where Russell 3000 technology Growth stocks rose +8.6% but Russell 3000 technology Value stocks fell -0.5%. 

Since the beginning of the year, we have increased the weight in industrials, consumer staples, and real estate while trimming the weight in technology.  In industrials we have identified attractive opportunities in cyclical businesses that are unrelated and have very different end markets.  Consumer staples has been the market’s worst-performer year-to-date and thus valuations have improved, particularly relative to the rest of the market.  In real estate, we have identified an eclectic mix of distinct opportunities even though we continue to find the broad sector as richly valued.  In technology, we trimmed select positions that had outperformed in lieu of valuation opportunities elsewhere. 

The equity market’s valuation appears above average, but this is heavily influenced by certain market segments that we view as considerably overvalued.  Excluding these segments, market valuations appear more reasonable.  Also, because growth has outperformed value to such a large extent, the price of select value stocks remains attractive.  We believe that a rising interest rate environment will be especially challenging for growth stocks as they are long duration assets whose present values will be severely discounted with an interest rise.   We are confident that the cycle will shift in favor of value once again, and our clients are well positioned to benefit. 

The portfolio continues to trade at a considerable valuation discount to the market, which is why we believe our clients should be rewarded if/when the growth/value cycle turns.  The portfolio trades at 7.8x normal earnings compared to 17.5x for the S&P 500; the price-to-book value of the portfolio is 1.3x vs. 3.2x the S&P 500.  

ATTRIBUTION: 2Q 2018

The Hotchkis & Wiley Value Opportunities portfolio (gross and net of management fees) outperformed the S&P 500 Index in the second quarter of 2018.  The overweight and positive security selection in energy led the outperformance in the quarter.  Positive security selection in consumer staples, real estate, and consumer discretionary also helped.  Security selection in technology along with the overweight position in financials detracted from performance.  The largest individual contributors to relative performance were Whiting Petroleum, Seritage Growth Properties, Discovery, Frank’s International, and Ericsson; the largest detractors were WestJet, Hewlett-Packard Enterprise, ARRIS International, Societe Generale, and Vodafone.  

LARGEST NEW PURCHASES: 2Q 2018

Amerco, through its primary subsidiary U-Haul, offers truck, trailer, and self-storage rentals across its 22,000 locations in the US and Canada.  U-Haul is over 10x larger than its next largest competitor and has more locations than all US rental car companies combined.  In addition, the company has significant optionality in its self-storage business and real estate assets.  These advantages, combined with Amerco’s attractive valuation, make the stock compelling.

Comcast is the largest cable service provider in the US and owns the NBCU media conglomerate. Comcast’s price does not reflect the growth it should produce as it continues to take share of the video and broadband markets. Comcast has the potential to grow at the expense of technologically inferior competitors and has strong record of returning cash to shareholders.

Corning is a materials sciences company that sells glass, ceramic, and advanced plastic products. Corning is priced at a modest multiple of current earnings for an outstanding business.  We believe Corning will be able to sustain a permanent margin advantage over its competition. Our conservative normal earnings estimate assumes no improvement from several new products that could each drive material earnings growth as glass use penetrates different industries. 

Composite performance for the strategy is located on the Performance tab. Returns discussed can differ from actual portfolio returns due to intraday trades, cash flows, corporate actions, accrued/miscellaneous income, and trade price and closing price difference of any given security. Portfolio attribution is based on a representative Value Opportunities portfolio. Certain client portfolio(s) may or may not hold the securities discussed due to each account’s guideline restrictions, cash flow, tax and other relevant considerations. Equity performance attribution is an analysis of the portfolio's return relative to a selected benchmark, is calculated using daily holding information and does not reflect management fees and other transaction costs and expenses. Specific securities identified are the largest contributors (or detractors) to the portfolio’s performance relative to the S&P 500 Index. Other securities may have been the best and worst performers on an absolute basis. The “Largest New Purchases” section includes the three largest new security positions during the quarter based on the security’s quarter-end weight adjusted for its relative return contribution; does not include any security received as a result of a corporate action; if fewer than three new security positions at quarter-end, all new security positions are included.  Securities identified do not represent all of the securities purchased or sold for advisory clients, and are not indicative of current or future holdings or trading activity.  H&W has no obligation to disclose purchases or sales of the securities.  No assurance is made that any securities identified, or all investment decisions by H&W were or will be profitable. The value disciplines used in managing accounts in the Value Opportunities strategy may prevent or limit investment in major stocks in the S&P 500, Russell 3000 Value and Russell 3000 Growth indices and returns may not be correlated to the indexes.  Quarterly characteristics and portfolio holdings are available on the Characteristics and Literature tabs. For a list showing every holding’s contribution to the overall account’s performance and portfolio activity for a given time period, please contact H&W at hotchkisandwiley@hwcm.com.  Portfolio information is subject to the firm’s portfolio holdings disclosure policy.
 
The commentary is for information purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Portfolio managers’ opinions and data included in this commentary are as of June 30, 2018 and are subject to change without notice.  Any forecasts made cannot be guaranteed.  Information obtained from independent sources is considered reliable, but H&W cannot guarantee its accuracy or completeness. Certain information presented is based on proprietary or third-party estimates, which are subject to change and cannot be guaranteed. Equity securities may have greater risks and price volatility than U.S. Treasuries and bonds, where the price of these securities may decline due to various company, industry and market factors.  Investing in value stocks presents the risk that value stocks may fall out of favor with investors and underperform growth stocks during a given period. The strategy may be exposed to more individual stock volatility than a more diversified strategy and may also invest in smaller and/or medium-sized companies, foreign securities, and debt securities. All investments contain risk and may lose value. 
 
Past performance is no guarantee of future results.
 

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