QTD Large Cap – 4Q2023 vs. R1000V
Market Observations & Portfolio Commentary
Large Cap – 4Q2023 vs. R1000V
Quarterly Market Update
U.S. equities rallied during 4Q with the major indices posting double-digit returns. Moderating inflation, some weakening in the labor market, and slowing economic growth raised the odds of a soft landing. The easing of financial conditions combined with indications by the Federal Reserve that it would pivot to rate cuts later in 2024 set forth a positive feedback loop for risk assets in 4Q. For the quarter, the Russell 3000 Index rose 12.1%.
There was a notable broadening of market strength in 4Q, as Small and Mid-Cap stocks posted the strongest gains. The recent broadening out of the market was a welcome reprieve, yet the cap-weighted Large Cap indices remain historically top-heavy and the mega-cap Magnificent 7 (Apple, Microsoft, Amazon, NVIDIA, Alphabet, Tesla, & Meta Platforms) were dominant in 2023. Some of the biggest beneficiaries of the 4Q drop in yields were the biggest victims of the rise in yields: regional banks, property stocks, cyclical sectors, and low quality, highly levered companies. Looking at market factors, Volatility and Growth were positive in 4Q while Value and Yield factors were mixed. Quality and Momentum factors were the biggest detractors during the final quarter.
Key Performance Takeaways for the Year
The London Company Large Cap portfolio gained 7.6% (7.5% net) during the quarter vs. a 9.5% increase in the Russell 1000 Value Index. Sector exposure was a tailwind, but was more than offset by stock selection.
The Large Cap portfolio lagged the Russell 1000 Value in 4Q and came up short of our 85-90% upside capture expectations. The portfolio faced headwinds from exposure to lower beta and higher quality holdings as well as underexposure to Growth & Volatility factors. Although our Energy underweight was beneficial, the rise of GLP-1 weight loss drugs adversely impacted consumer staples stocks, where we are overweight.
Our balance sheet strength value proposition proved to be more of a luxury than a necessity in 2023, but we believe that focus will become a tangible advantage in the years ahead, as we face an economic slowdown with a higher cost of capital environment.
Top 3 Contributors to Relative Performance
BlackRock (BLK) – BLK rallied in 4Q after underperforming earlier in the year. BLK performance from quarter to quarter is often a function of market performance, which drives the company’s assets under management. Our conviction in BLK remains high based on the company’s durable competitive position, under-levered balance sheet, persistently strong profitability, and capital return.
Martin Marietta (MLM) – MLM outperformed in 4Q as it continues to exhibit strong pricing power despite lower aggregate volumes. Management noted their expectations for strong revenue growth next year supported by higher prices and accelerating infrastructure spend. MLM’s leadership position within aggregates and exposure to key markets gives us confidence that it will benefit from growth in construction and infrastructure spending for years to come.
Charles Schwab (SCHW) – SCHW posted growth in net assets, with some of the headwinds around the TD integration clearing. We believe SCHW is well positioned to show a sharp rebound in 2024 and 2025 earnings as near-term issues resolve naturally. We continue to like SCHW’s strong competitive position, growth outlook, high incremental margins, and excellent management team.
Top 3 Detractors from Relative Performance
Albemarle (ALB) – 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.
FedEx (FDX) – After a very positive start to the year, FDX lagged during 4Q after a weak earnings report and lowered guidance. Fundamentals improved throughout the year as FDX enacted major cost cuts, but a decline in volumes in the quarter was too much for the new cost structure to overcome. Longer term, FDX has the potential to be a strong player in the transportation industry, but it will have to continue adjusting its fleet and network to an evolving marketplace.
Chevron (CVX) – CVX underperformed during 4Q as oil prices fell, 3Q results missed expectations, and CVX negatively adjusted 2024-2025 cash flow guidance for its key asset in Kazakhstan. It is also notable that CVX announced a deal to acquire Hess Corp in a stock-for-stock transaction. While we generally do not maintain a high degree of exposure to pure commodity businesses, we continue to view CVX favorably for its conservative balance sheet, focus on returns, and commitment to the dividend.
We are bottom-up stock pickers, but sector exposures influenced relative performance as follows:
What Helped: Underweight both Energy & Health Care (two weaker performing sectors)
What Hurt: Underweight Real Estate & Industrials (two better performing sectors)
Trades During the Quarter
There were no trades during the quarter.
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.
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.
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.