Actively managed large cap growth strategy that relies on fundamental research and analysis to identify companies with strong and accelerating business momentum, increasing market acceptance and attractive valuations.
- Markets bounced back in March after retreating in February, finishing off a mostly positive quarter. The banking crisis triggered fears of global banking contagion which caused a flight to safety, with Mega Cap stocks leading the overall market for the quarter.
- For the quarter, the Strategy underperformed its benchmark, the Russell 1000 Growth Index (the Index), on a net asset value (NAV) basis, due to unfavorable stock selection and allocation effects.
- Although the US Federal Reserve hiked another quarter point in March, the market seems to be weighing if that could be the final rate hike of the year. The unprecedented rise in yields over the last year contributed to the recent bank failures, making a soft landing less likely, and increasing the likelihood of a recession.
The financial markets were positive in the first quarter, but volatile as concerns with inflation and interest rates tugged asset prices up and down. At its first 2023 policy meeting, the Fed raised interest rates by 25 basis points (bp), driving market rates higher while pulling down bond prices and crimping the values of rate-sensitive technology stocks. Market focus shifted dramatically in March as the sudden failure of several US regional banks and the collapse of Credit Suisse shook the banking sector. Markets regrouped after the government intervened to protect depositors. The Fed, seeking to avoid further “accidents” tied to higher rates, took a restrained step and increased the Fed funds rate by just another 25 bp at its March policy meeting.
The 10-year US Treasury yield fell from nearly 3.9% in early January to less than 3.5% by quarter-end. Falling rates helped both stocks and bonds. The S&P 500 Index gained 7.50% and the Bloomberg US Aggregate Bond Index gained 2.96%. Easing rates also gave growth stocks an advantage over value stocks ― across the capitalization spectrum, growth styles posted gains significantly greater than those of value styles.
For the quarter ended March 31, 2023, the Strategy underperformed the Index on a NAV basis due to unfavorable stock selection and allocation effects. Stock selection in the financials and energy sectors contributed the most to performance. Unfavorable stock selection in the consumer discretionary, and to a lesser extent, communication services and health care sectors, detracted the most. An allocation to cash and unfavorable allocation to health care also weighed on performance.
Key contributors to performance were Palo Alto Networks Inc., NVIDIA Corp. and AbbVie Inc.
An overweight position in Palo Alto Networks Inc. (PANW) contributed to performance. The company reported strong results during the period, balancing top-line growth with strong margin performance. Results were driven by strong execution and the continued expansion of next-gen security in a challenging macro environment.
An aggregate overweight position in NVIDIA Corp. (NVDA) contributed to performance. The company reported solid quarterly results and provided higher than expected guidance. Strong gaming results offset some of the softness in China demand. Management also announced DGX Cloud, which is an artificial intelligence-as-a-service offering, partnering with Oracle, Microsoft Azure and Google Cloud Platform.
Not owning AbbVie Inc. (ABBV) contributed to performance. The company reported a mixed quarter during the period with the focus on 2023 guidance below consensus estimates. Humira sales are expected to be the primary driver of 2023 sales erosion.
Key detractors from performance were Tesla Inc., Eli Lilly and Co. and Enphase Energy Inc.
An underweight position in Tesla Inc. (TSLA) detracted from performance. The company reported better-than-expected earnings during the period and management is projecting around 40% growth for 2023. The electric vehicle tax credit in the Inflation Reduction act will also likely increase demand in the US.
An overweight position in Eli Lilly and Co. (LLY) detracted from performance. The company reported strong Verzenio sales but those were offset by lower-than-expected Mounjaro sales. The US Food and Drug Administration also issued a CRL (complete response letter), putting the brakes on the accelerated approval of Alzheimer’s drug donanemab.
An overweight position in Enphase Energy Inc. (ENPH) detracted from performance. Although ENPH reported strong quarterly results, demand within the US is becoming more uncertain as macroeconomic concerns are causing installers to pull in demand for future purchases. The unclear demand visibility has weighed on the share price.
Current Strategy and Outlook
Strains in parts of the financial system have prompted the Fed to trim its tightening plans. We believe quick action by regulators has largely addressed concerns of systemic risk in the banking system. In our view, bank balance sheets are healthy, and the lack of fundamental consumer and corporate imbalances should limit the severity of any sort of economic downturn that may materialize.
The long game still needs to play out: a higher cost of capital for banks will raise borrowing costs for companies and consumers, increasing the potential for a longer but still shallow recession. Since the challenges to the banking system are likely to be disinflationary, further Fed rate hikes may not be necessary. The focus now shifts to when the Fed might begin lowering rates. For that to happen, we believe labor markets and economic growth would need to weaken substantially — and that is not happening yet. Employment data remain vibrant despite an uptick in the unemployment rate, and the economy has remained remarkably resilient, supported by strong consumer spending.
Companies mentioned in this report – percentage of Strategy investments, as of 03/31/23: Palo Alto Networks Inc. 1.85%, NVIDIA Corp. 4.31%, AbbVie Inc. 0%, Tesla Inc. 0.47%, Eli Lilly and Co. 2.75% and Enphase Energy Inc. 1.07% ; 0% indicates that the security is no longer in the portfolio. Portfolio holdings are subject to daily change.