FY Large Cap – 2023 vs. R1000
Market Observations & Portfolio Commentary
Large Cap – 2023 vs. R1000
Full Year Market Update
For the year, the broader market posted solid gains, with the Russell 3000 up 26.0%. At the start of 2023, interest rates were rising, inflation was stubbornly high, and investors were bracing for a recession. Instead, inflation continued falling, consumers kept spending, and the unemployment rate fell to its lowest level since 1969. With slowing inflation, signs of better balance in the labor market, and normalized GDP growth expectations, the Federal Reserve indicated that it would pivot to rate cuts later in 2024. Huge rallies by the mega-cap Magnificent 7 (Apple, Microsoft, Amazon, NVIDIA, Alphabet, Tesla, & Meta Platforms) were a big driver of overall index performance, and narrow market leadership remained a nagging concern for much of the year.
It was a year of bifurcated performance, led by the mega-cap stocks. Enthusiasm over artificial intelligence and robust gains by the Magnificent 7 led to significant outperformance of the Growth Indices and helped mask weakness in other corners of the market. Non-dividend paying companies significantly outperformed companies that pay a regular dividend, especially in the large cap space. Turning to market factors for the year, Volatility and Growth factors posted the strongest results. Value, Yield, and Momentum factors presented headwinds; while Quality and Momentum factors delivered mixed results.
Key Performance Takeaways for the Year
The London Company Large Cap portfolio gained 14.8% (14.3% net) for the year vs. a 26.5% increase in the Russell 1000 Index. Both sector allocation and stock selection were headwinds.
Despite solid absolute performance, the Large Cap portfolio lagged its benchmark in 2023 and came up short of our 85-90% upside capture expectations. Exposure to higher yielding, slower growth, lower beta, and higher quality holdings presented headwinds relative to the Russell 1000 Index. The concentrated strength and skew from the Magnificent 7 diminished the relative impact of our Quality orientation.
Historically, a reliance on high Quality factors has proven to be a strategy that can lose battles along the way but tends to win the war over time. As the past few years have demonstrated, market trends and leadership can turn on a dime. We don’t chase the ups and downs of the risk trade; instead, we commit long-term capital to Quality companies that have greater control over their own destiny. While the full benefits of quality investing have been delayed at the large cap level, we don’t think they’ll be denied in the long term. In our view, the characteristics of the Large Cap portfolio remain attractive, and we believe we’re well positioned for an uncertain future.
Top 3 Contributors to Relative Performance
NewMarket (NEU) – NEU outperformed after reporting solid earnings in recent quarters reflecting a recovery in pricing and margins after a long period of higher base oil and chemical prices. NEU also used stronger cash flow to repay debt and repurchase company shares. Late in the year, NEU announced the planned acquisition of American Pacific Corp., a manufacturer of solid rocket propellants and fire suppressants. This acquisition will help diversify the business away from petroleum additives, which is likely in long-term decline.
Alphabet (GOOG) – GOOG’s outperformance this year reflected stabilization in the Search business, momentum in the Cloud segment, and better cost control execution. GOOG continues to find ways to monetize the business and improve efficiency. GOOG continues to invest in the business and return capital to shareholders via its buyback program. GOOG has a solid balance sheet, significant market share, and generates strong returns.
Martin Marietta (MLM) – MLM outperformed for the year as it exhibited strong pricing power and margin expansion. Public infrastructure and commercial end markets are expected to remain resilient with record government funding supporting highway development and on-shoring trends. MLM’s leadership position within aggregates and exposure to financially healthy states gives us confidence that it will benefit from growth in both infrastructure and construction spending for many years.
Top 3 Detractors from Relative Performance
Charles Schwab (SCHW) – SCHW was weak early in the year reflecting broader banking concerns and cash sorting. The Silicon Valley Bank implosion gave rise to a misinformed bear narrative that SCHW would face insolvency from bank runs and client cash sorting. We strongly disagreed and believed that SCHW had ample short-term financing to shield them from having to realize any losses on their securities book. Meanwhile, multiple members of senior management and the board all stepped up to buy stock. While we concede that there may be short-term headwinds to earnings from elevated cash sorting, the long-term growth and earnings power of the company remains intact.
Albemarle (ALB) – We purchased shares of ALB during 2Q. Following our purchase, ALB underperformed as weak lithium prices drove downward revisions to earnings expectations, and sentiment became more negative regarding demand for electric vehicles. Commodity prices are inherently uncertain, but we continue to view ALB as a winner in this growing industry and favorably positioned on the cost curve. Our long-term view of ALB is not affected by short-term supply-demand dynamics for the commodity.
Pfizer (PFE) – PFE underperformed in 2023 as the market focused on declining COVID franchise earnings and upcoming patent expirations. We retained the position in our Large Cap portfolio, as we believe in the long-term opportunity for the business to leverage PFE’s leading R&D capabilities along with its strong financial profile.
We are bottom-up stock pickers, but sector exposures influenced relative performance as follows:
What Helped: Underweight Health Care and Utilities (two weak performing sectors)
What Hurt: Underweight Information Technology (a better performing sector) and overweight Financials (a weaker performing sector)
Portfolio Characteristics & Positioning
We believe the Large Cap portfolio is positioned for long-term durability and possesses the fundamental ingredients that stand the test of time: wide moats, sustainably high returns on capital, strong cash flow generation, low leverage ratios, and trading at an attractive discount to the Russell 1000. As access to capital becomes more difficult and the cost of that capital is more expensive, we believe companies with strong balance sheets and the ability to self-fund their operations could have a structural advantage in 2024 and beyond. In an environment of possibly lower returns and greater volatility, we believe the Large Cap portfolio offers a compelling option for equity investors.
After such a strong 2023, we believe investors should temper expectations for 2024. Stocks defied rate hikes, wars, collapsed banks, and recession fears in 2023. Now, calls for a soft landing are consensus; sentiment is overly optimistic; and markets are priced for very little risk. Predicting the future direction of the economy is always challenging. While we do agree the odds of a recession have come down, they are still elevated. A soft landing remains in reach, but much of that hinges on whether the Fed eases soon enough to avoid an employment problem. Perhaps this time it will be different, but historically the odds of sticking the landing have been very low. Even though we have greater clarity over the Fed’s path from here, there still remains a long list of items creating uncertainty that could lead to greater volatility in 2024.
In terms of the equity market, we believe returns in the near term may be modest, with shareholder yield (dividends, share repurchase, debt reduction) comprising a significant percentage of the total return. Economic growth is likely to slow; earnings estimates appear optimistic; and valuations are somewhat elevated. Moreover, investors continue to expect a faster pace of rate cuts than members of the FOMC currently suggest. The difference in the pace of rate reductions could lead to greater levels of volatility in 2024. Markets are impossible to outguess in the short run, but we believe the antidote to uncertainty is quality and that solid company fundamentals will lead to strong risk-adjusted returns in the long run. With that in mind, the characteristics of our portfolios remain attractive, and we believe we’re well positioned for an uncertain future.
We believe the Large Cap portfolio is positioned for long-term durability and possesses the fundamental ingredients that stand the test of time.
As of 12/31/2023
Inception date: 6/30/1994. Past performance should not be taken as a guarantee of future results. Performance is preliminary. Subject to change.