ALC - ClearBridge Large Cap Growth Strategy Q2 2023 Portfolio Manager Commentary

2023-07-13 11:45:00 ET

Summary

• ClearBridge is a leading global asset manager committed to active management. Research-based stock selection guides our investment approach, with our strategies reflecting the highest-conviction ideas of our portfolio managers.
• The ClearBridge Large Cap Growth Strategy outperformed its benchmark in the second quarter.
• Improved stock selection and patience with the earnings recovery of several positions enabled the Strategy to outperform the benchmark for the third straight quarter.
• Positioning moves through the COVID-19 recovery have supported greater participation in up markets and resilience during turbulent periods. Our latest activity has been geared to narrowing an underweight to technology and opportunistically adding to newer holdings.

By Peter Bourbeau & Margaret Vitrano

Perseverance Paying Off in Narrow Market

Market Overview

Growth stocks remained in favor in the second quarter, with enthusiasm over generative AI extending gains for mega cap companies in a historically narrow market. The S&P 500 Index ( SP500 , SPX ) rose 8.74% and the Nasdaq Composite ( COMP.IND ) climbed 13.1% as investors took cooling inflation to mean the Federal Reserve’s tightening cycle is near its conclusion. The benchmark Russell 1000 Growth Index maintained its positive momentum, advancing 12.81% and outperforming the Russell 1000 Value Index (+4.08%). Growth is ahead of value by ~2,400 basis points year-to-date.

2023 has so far marked a return to mega cap leadership, with Apple ( AAPL ), Microsoft ( MSFT ), Alphabet ( GOOG , GOOGL ) , Amazon.com ( AMZN ) and Nvidia ( NVDA ) accounting for approximately two thirds of the benchmark return (Exhibit 1). The momentum of these growth stocks was reflected in second-quarter leadership with information technology (IT,+19.25%) the best performer while communication services (+16.26%) and consumer discretionary (+15.84%) also outperformed. Energy (-1.39%) and real estate (-1.30%) suffered losses while consumer staples (+0.03%), utilities (+0.12%), health care (+4.58%), financials (+5.72%), industrials (+6.09%) and materials (+10.26%) also underperformed.

Exhibit 1: Mega Cap Performance Illustrates Narrow Breadth

At 41.3%, the five largest stocks in the market represent the highest concentration in the 26-year history of the Russell 1000 Growth Index. Among these names, we maintain overweights to Nvidia (+246 bps) and Amazon (+117 bps), underweights to Microsoft (-353 bps) and Apple (-829 bps) and no exposure to Alphabet.

Exhibit 2: Market Concentration Hitting Historical Levels

While such concentration had been a headwind in the past, the ClearBridge Large Cap Growth Strategy has outperformed through this latest high-beta-driven period of mega cap dominance due to improved stock selection and patience. Positioning activity through the COVID-19 recovery has been focused on increasing exposure to select growth stocks that provide greater participation in up markets and balancing the portfolio with countercyclical holdings that can provide ballast during turbulent periods.

Delivering performance through fundamental, bottom-up stock selection has been a constant over our tenure managing the Strategy. We underperformed in the first half of 2022 from being too early in entering several stocks going through negative earnings revisions and have seen relative results rebound over the last 12 months due to better stock picking, especially among earnings reset names such as Netflix ( NFLX ) and Meta Platforms ( META ). The Strategy’s IT holdings also drove performance in the second quarter, led by the continued rerating of graphics chipmaker Nvidia as a key beneficiary of the generative AI boom. AI-connected holdings Microsoft and Amazon also delivered strong gains.

Nvidia is a good example of a select growth stock bought opportunistically where our long-term thesis has bloomed. We initiated the position in the fourth quarter of 2018 knowing that inference and training in the data center was an interesting although still early-stage growth driver. We knew that GPUs could be used to solve complex computing problems, but we didn’t know how quickly the training and learning efforts by Nvidia’s mega cap customers would hit an inflection point. Volatility in the gaming business created the entry point into the stock and we have built the position accordingly over time. Since the end of 2021, the stock’s portfolio weight grew from 4.5% to a high of 7.2% earlier in the second quarter before we trimmed it to manage our overall position sizing.

We will continue to monitor and adjust Nvidia’s position sizing to manage risk. Despite the sharp run up, we believe the company’s long-term runway remains compelling due to its advantaged positioning in a very large addressable market for GPUs. The current valuation looks expensive, yet Nvidia has real earnings and cash flow and the longer-term multiple looks more reasonable because of GPU pricing power.

Supporting our widely-held names in the second quarter were solid contributions in health care, where we benefited from an overweight to medical device stocks Intuitive Surgical ( ISRG ) and Alcon ( ALC ) which moved higher on signs of improving procedure growth. Supply chain headwinds and labor shortage bottlenecks are now easing while ambulatory surgery centers are adding more surgery hours, which should be a boon to these stocks as well as to orthopedic and spine surgery products specialist Stryker ( SYK ). Newer holding Eli Lilly ( LLY ) also rose strongly on greater than expected demand for its diabetes and obesity treatment. In industrials, the Strategy has benefited from a steady climb in the shares of global rideshare leader Uber and electrical components maker Eaton.

Portfolio Positioning

Quarterly results were partially offset by weakness among the portfolio’s consumer holdings as well as an 800 bps IT underweight. We have been cognizant of our lower IT exposure and had purposefully been positioned this way in 2022 to manage the headwinds of rising interest rates and what we had expected to be a slowing in enterprise IT spending. AI enthusiasm may now provide more of a floor on spending than previously anticipated and as a result we are now inching toward the middle from a previously defensive positioning stance. This activity has involved consistently trimming our health care overweight over the past three quarters as well as leveraging opportunities to close the gap in our IT coverage.

"Improved procedure growth should be a boon to medical device stocks, which are benefiting from easing supply chain headwinds and labor shortage bottlenecks."

Taking advantage of post-earnings weakness, we initiated a position in Intuit ( INTU ), a provider of software for small business accounting and tax preparation under the QuickBooks and TurboTax brands as well as personal finance (Credit Karma) and marketing services (Mailchimp). We see a clear path to upside earnings revisions as the company expands new products that increase its total addressable market and drive average revenue per user growth.

We increased our position in marketing and design software maker Adobe ( ADBE ). The company is protecting its leadership position by moving quickly into generative AI and license protection. It developed Firefly into a product that can be monetized, moving AI from a previously perceived risk into an opportunity. Also within shadow tech, we added back to our weighting in Meta as steady advertising trends and continued cost management should lead to improved profitability.

Outlook

The economy is sending mixed signals, with a resilient job market and better than expected consumer spending thus far neutralizing the impact of restrictive monetary policy. With labor costs still too high to support the Fed’s inflation fight, Chairman Jay Powell expects at least two more interest rate increases in the second half of the year. Meanwhile, manufacturing has contracted for eight straight months and we remain cautious as the lagged effects of aggressive tightening have yet to be fully felt across the broader economy. Companies remain cautious about earnings, with 67 in the S&P 500 Index issuing negative guidance for the second quarter compared to 46 issuing positive guidance.

We have refreshed our whiteboard and will look to take advantage of such downside earnings revisions among early cycle recovery plays in industrials and consumer discretionary. We are targeting quality themes in the consumer space where estimates have been partly de-risked, similar to the scenario that prompted the purchase of Estee Lauder ( EL ) in the fourth quarter. Such names should be well-positioned to deliver improved earnings on the other side of an eventual recession.

While positioning has become less defensive, a low growth macro environment remains our base case. Following strong participation in a narrow market the first five months of the year, we saw a modest broadening of leadership in June and believe our diversified approach across the growth spectrum is the most prudent way to invest going forward.

Portfolio Highlights

The ClearBridge Large Cap Growth Strategy outperformed its benchmark in the second quarter. On an absolute basis, the Strategy posted gains across eight of the 10 sectors in which it was invested (out of 11 sectors total). The primary contributor to performance was the IT sector.

Relative to the benchmark, overall stock selection contributed to performance. In particular, stock selection in the IT, health care, communication services and industrials sectors supported results. Conversely, an underweight to IT, overweights to financials and health care and stock selection in the consumer discretionary and consumer staples sectors detracted from performance.

On an individual stock basis, the leading absolute contributors were positions in Nvidia, Amazon, Microsoft, Meta Platforms and Apple. The primary detractors were Estee Lauder, Thermo Fisher Scientific ( TMO ), PayPal ( PYPL ), Nike ( NKE ) and Sea Limited (SE).

Peter Bourbeau, Managing Director, Portfolio Manager

Margaret Vitrano, Managing Director, Portfolio Manager

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

For further details see: