Market Summary
The pessimism of 2022 continued into the third quarter, as the majority of major indexes again posted negative results for the quarter. War in Europe, runaway inflation, rising interest rates and expectations of a collapse in corporate profits weighed on capital asset prices.
The Federal Reserve is raising interest rates at the fastest pace in four decades, in an attempt to control the highest inflation that we have seen during those 40 years. The most recent Fed policy meeting resulted in a 0.75% interest-rate rise, its third in a row. While the rise was forecasted, the central bank offered a surprise: new projections revealed that rates will likely rise to more than 4.5-4.75% at the end of 2023, exceeding market expectations.
Meanwhile, the unemployment rate increased slightly to 3.7%; however, it remains historically low and there is still a shortage of workers. The demand for labor, coupled with rising prices continues, to lead to wage pressure. From September 2021 to September 2022, the Consumer Price Index (CPI) increased by 8.2%.
Performance Highlights
The Snow Focused Value strategy returned -2.36% gross of fees during the quarter (-2.59% net of fees) while the Russell 1000 Value Index declined -5.62%. The strategy is outperforming the Russell 1000 Value by 496 basis points through the first three quarters of 2022.
The Focused Value portfolio outpaced its benchmark for the quarter due to both stock selection and sector positioning. Stock selection was notably strong in Health Care, Industrials, and Consumer Staples, but lagged in Consumer Discretionary. The portfolio benefited from its overweight allocation to Consumer Discretionary and underweight to Real Estate.
Portfolio Attribution
Top 5 Performance Contributors
| Stock | Avg Weight % | Contribution % |
|---|---|---|
| Cardinal Health | 5.02 | 1.22 |
| HF Sinclair | 5.30 | 0.98 |
| Lamb Weston Holdings | 4.93 | 0.51 |
| WESCO International | 4.47 | 0.44 |
| Regions Financial | 4.38 | 0.30 |
Cardinal Health (CAH)
CAH shares appreciated as investors supported a management change and the company detailed plans to improve the profitability of its medical products manufacturing and distribution business. We expect CAH will re-rate closer towards its peer group as margins expand.
HF Sinclair (DINO)
DINO increased during the quarter as the company posted signs of improving execution at its key refineries. Supported by the rise in margins for refined products, DINO generated significant cash flow and began executing on a large share repurchase. With demand for gasoline and jet fuel returning to normalized levels, as well as a reduction in global supply capacity, the outlook for refining margins remains healthy.
Lamb Weston Holdings (LW)
Shares of LW positively contributed to performance as the company issued a strong quarterly report and provided upbeat margin guidance for the second half of 2023. While inflation and supply chain pressures persist, LW should benefit from price increases and an improving potato crop.
Top 5 Performance Detractors
| Stock | Avg Weight % | Contribution % |
|---|---|---|
| Kohls | 2.77 | -0.80 |
| PVH | 3.39 | -0.78 |
| Hasbro | 3.65 | -0.66 |
| Suncor Energy | 0.51 | -0.56 |
| Lions Gate Entertainment | 2.33 | -0.49 |
Kohl’s (KSS)
Shares of KSS negatively impacted performance as the company posted disappointing results in the face of weakening consumer demand. Despite the weakness in the quarter, KSS reiterated its long-term margin guidance and is executing on its accelerated share repurchase. We believe that in a normalized environment, KSS earnings can improve significantly.
PVH (PVH)
Shares of PVH underperformed along with several Consumer Discretionary stocks in the face of weakening consumer demand. PVH shares were also pressured from a strengthening US dollar relative to the Euro. PVH has several tailwinds, including an accretive brand shift, re-opening tailwinds in China, a multi-year strategy to accelerate growth, and a recently announced repurchase authorization. We continue to find PVH shares attractive, trading for 5.9x depressed forward earnings estimates.
Hasbro (HAS)
Shares of HAS negatively impacted performance after pulling back late in the quarter along with the market. HAS held a well-received investor day in early October, detailing plans to unlock value as the company plans to transform from a toy manufacturer to a global entertainment brand.
Trailing Performance
*as of September, 2022
| QTD | 1 Yr | 3 Yr | 5 Yr | 7 Yr | 10 Yr | Since Inception* * | |
|---|---|---|---|---|---|---|---|
| Composite (Gross) | -2.36% | -6.70% | 9.18% | 5.83% | 7.70% | 9.70% | 13.16% |
| Composite (Net) | -2.59% | -7.60% | 8.12% | 4.79% | 6.65% | 8.66% | 12.15% |
| Russell 1000 Value | -5.62% | -11.36% | 4.36% | 5.28% | 8.14% | 9.17% | 10.46% |
Calendar Year Performance
| 2022 | 2021 | 2020 | 2019 | 2018 | 2017 | 2016 | 2015 | 2014 | 2013 | |
|---|---|---|---|---|---|---|---|---|---|---|
| Composite (Gross) | -12.80% | 31.80% | 2.57% | 28.00% | -18.03% | 17.76% | 15.10% | -18.20% | 15.17% | 50.18% |
| Composite (Net) | -13.43% | 30.54% | 1.53% | 26.81% | -18.87% | 16.61% | 13.97% | -19.03% | 14.02% | 49.10% |
| Russell 1000 Value | -17.75% | 25.16% | 2.80% | 26.54% | -8.27% | 13.66% | 17.34% | -3.83% | 13.45% | 32.53% |
Source: SEI Global Services
* Returns for periods greater than a year are annualized. Past performance is not indicative of future results.
** Inception: 12/31/08
Top 10 Holdings
| HF Sinclair | 5.80% |
| Centene | 5.61% |
| Cardinal Health | 5.38% |
| Coterra Energy | 4.87% |
| Lamb Weston Holdings | 4.81% |
| Amgen | 4.76% |
| WESCO International | 4.73% |
| Hartford Financial Services | 4.60% |
| MetLife | 4.59% |
| Walt Disney | 4.56% |
| Total | 49.74% |
|---|
Total Effect Attribution vs Russell 1000 Value
Outlook
The central bank’s tightening cycle has been a tailwind to value investing. While investment style trends oscillate over time, there have been extended stretches where the market rewards either growth or value, only to be followed by a reversal and subsequent outperformance by the opposite style. For the year-to-date period, value stocks have outperformed growth stocks. In our view, we are in the early stages of a cycle rotation where investors will continue to reward value over growth. After over a decade of growth outperforming value, the valuation spread between the two styles continues to remain wide. We expect inflation to pull back from the past year’s high, but we anticipate it to remain above its long-term average.
Higher average accelerations in underlying prices often coincide with investors rewarding value stocks. Low price-to-earnings companies produce cash flows that track inflation and the revenue streams of these assets are typically tied to higher prices as well. Meanwhile, the spike in interest rates will likely degrade the forward price-to-earnings multiples of some corners of the market, particularly higher growth stocks. This will relatively hamper growth, more than value, turning investors towards favoring stocks with strong fundamentals.
Even in the face of uncertainty and the potential risk of recession, our longer-term outlook for the U.S. economy and the stock market remains unequivocally bullish. Looking into the upcoming quarters, the key variables for investors will be the magnitude and duration of a likely recession. Further, the direction of equity prices will respond to GDP gauges, inflation reports and the Central Banks’ response to it.
All told, we continue to hold companies with compelling business fundamentals, skilled management teams, reoccurring cash flows, and the flexibility to adapt to an inflationary environment. We believe these stocks will compound earnings over an extended period through both rising and declining markets. Our portfolio of stocks is significantly discounted based on relative multiple valuations, compared to its benchmark. We remain dedicated to delivering strong long-term performance and transparent communications to our investors. As always, we welcome your comments and questions. Thank you for your commitment to Easterly Investment Partners.
Disclosures
Easterly Investment Partners (EIP) is a registered investment adviser. Registration of an Investment Advisor does not imply any level of skill or training. This composite has been assigned to Easterly Investment Partners (EIP) effective July 1, 2021. Performance presented prior to July 1, 2021, occurred while the Portfolio Manager(s) and the research team were affiliated with a prior firm (Snow Capital Management, L.P.). EIP claims compliance with the Global Investment Performance Standards (GIPS®). A fully compliant GIPS presentation along with a complete list and description of all composites is available upon request. The Focused Value composite contains fully discretionary accounts consisting of an equity portfolio of less than 25 stocks that invests at least 80% of assets in companies with market capitalizations greater than $1 billion and dates back to December 31, 2008. This composite has no minimum requirement and for comparison purposes is measured against the Russell 1000 Value. The U.S. Dollar is the currency used to express performance. Leverage is not used in this composite. Investing involves risk; clients may experience a profit or a loss. Past performance is not indicative of future results. Performance is preliminary. Composite returns are shown gross of fees and do not reflect the deduction of advisory fees. Actual returns are shown gross of fees and do not reflect the deduction of advisory fees. Actual returns will be reduced by advisory fees and other expenses incurred in the management of the account. EIP’s advisory fees are outlined in our Form ADV Part 2A (Brochure), which is available upon request.
The effect of an advisory fee compounded over a period of years, on the total value of a client’s portfolio is represented by the following example. Assuming an initial portfolio of $1 million earning a 10% return each year which incurs an annual advisory fee of 1.0% payable quarterly in advance, the portfolio would be worth $1.53 million net of fees and $1.61 million gross of fees after 5 years, $2.37 million net of fees and $2.59 million gross of fees after 10 years and $3.58 million net of fees and $4.15 million gross of fees after 15 years. Past performance is not guarantee of future results. The performance of any individual portfolio may vary from the Composite’s performance.
The performance figures are based on a composite of many accounts and not all accounts owned the securities mentioned in this commentary. Holdings and sector allocations are subject to change. The latest copy of our Form ADV Part 2A (Brochure) and a complete list and description of EIP’s composites and/or a presentation that adheres to the Global Investment Performance Standards (GIPS®) is available upon request.
Russell 1000® Value Index
The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. Indexes are unmanaged. It is not possible to invest directly in an index.