Actively managed portfolio aiming to achieve a dividend yield that exceeds the average dividend yield of the companies included in the Russell 1000® Value index.
- After much speculation over when the seemingly inevitable recession would hit, markets have continued to defy the narrative with yet another strong quarter. Unemployment remains at historic lows and the economy has thus far shown itself to be much more resilient than expected.
- For the quarter ended June 30, 2023, the Strategy underperformed the Russell 1000 Value Index (the Index) on net asset value (NAV) basis, due to unfavorable stock selection and allocation effects. The selection in the health care, financial, and industrials sectors contributed the most to performance. Conversely, selection in the communication services, and to a much lesser degree, information technology and energy sectors detracted from performance.
- With inflation easing, it appears that the U.S. Federal Reserve is nearing the end of the rate-hike cycle. We are cautiously optimistic that we can achieve the soft landing scenario.
U.S. equity markets performed well during the second quarter, with most of the gains made in June. Stocks were buoyed by relief over Congress’s passage of the bill to raise the debt ceiling. The S&P 500 Index notched its best monthly performance of 2023 during the final month of the period, gaining 6.61% in June and 8.74% for the quarter. Information technology stocks delivered strong performance during the quarter, driven by artificial intelligence and chip manufacturers. Growth stocks outperformed value stocks during the period. After poor performance in April and May, small caps rebounded in June and outperformed larger stocks.
Volatility in the U.S. bond market continued during the quarter. The Bloomberg U.S. Aggregate Bond Index lost –0.84%, while the 10-year U.S. Treasury yield rose from 3.43% at the beginning of the quarter to 3.81% by quarter-end. The Fed raised rates by 25 basis points twice during the period, bringing the Fed funds rate to a range of 5.00–5.25%, but did not implement a hike at its June meeting. Still, Fed officials maintained a hawkish stance through the end of the quarter; although core inflation has decreased significantly from 2022, it has persisted well above the 2% target. The Fed’s “dot plot,” which serves as a predictor of rate movements, indicates two additional hikes this year.
For the quarter ended June 30, 2023, the Strategy outperformed the Index due to stock selection and allocation effects. The selection in the health care, financial and industrials sectors contributed the most to performance.
Owning a non-benchmark position in Apollo Global Management Inc. and overweight positions in Arthur J. Gallagher & Co. and Howmet Aerospace Inc. added the most to performance.
Owning a non-benchmark position in Apollo Global Management Inc. (APO) contributed to performance. The company reported a solid quarter and raised forward guidance. High interest rates are boosting organic growth in the retail channel, flow reinsurance is ramping, and pension risk transfer activity is picking up as well.
An overweight position in Arthur J. Gallagher & Co. (AJG) contributed to performance. The company reported a strong quarter behind stronger organic growth. Management has yet to detect any recessionary pressure from its middle-market client base.
An overweight position in Howmet Aerospace Inc. (HWM) contributed to performance. The company reported a strong quarter behind higher sales and margins. HWM also raised guidance.
Conversely, selection in the communication services, and to a much lesser degree, information technology and energy sectors detracted from performance.
Overweight positions in AT&T Inc. and Kraft Heinz Co. and not owning Meta Platforms Inc. were the biggest individual detractors.
An overweight position in AT&T Inc.(T) detracted from performance. The company reported a mixed quarter with less free-cash-flow (FCF) than anticipated.
An underweight position in Meta Platforms Inc. (META) detracted from performance. The company reported a strong quarter, beating street estimates across the board. Management has also continued to trim 2023 operating expenses and raised revenue guidance.
An overweight position in Kraft Heinz Co. (KHC) detracted from performance. The company reported a solid quarter during the period, but trimmed estimates, resulting from visibility on consumer challenges from elevated Supplemental Nutrition Assistance Program (SNAP) payments ending, student loan payments resuming, inflationary pressure and falling levels of elevated savings from stimulus.
Current Strategy and Outlook
The U.S. economy has remained resilient as have corporate earnings, fueling the debate of a hard versus soft landing. We still believe there may be greater volatility to come given uncertainty over Fed rate policy in the second half of the year; mixed business sentiment and slowing economic growth; and whether a recession will actually happen, and if so, the duration and depth. The real story has been the resilience of corporate earnings and rise in equity valuations as interest rates begin to normalize. Using price-to-earnings (P/E) ratio as a proxy, valuations for the S&P 500 Index ended 2022 well below 2019 levels. However, despite elevated rates and tightening financial conditions in the first half of the year, valuations have expanded modestly. P/E ratios are still below 2019 levels, and we believe earnings expectations are reasonable, but this could change as we enter 2024 depending on the state of the U.S. economy.
Companies mentioned in this report – percentage of Strategy investments, as of 06/30/23: Apollo Global Management Inc. 2.24%, Arthur J. Gallagher & Co. 2.70%, Howmet Aerospace Inc. 2.28%, AT&T Inc. 4.12% and Kraft Heinz Co. 2.08% and Meta Platforms Inc. 0%; 0% indicates that the security is no longer in the portfolio. Portfolio holdings are subject to daily change.