Inflation and risk of a recession weighed on the market with most indexes posting negative results for the quarter. Consumers continued to grapple with high gasoline prices as oil surged to over $100 per barrel. Russia’s invasion of Ukraine, stretched refining capability, and strong consumer demand led to a 38% increase in oil since the start of the year.
Recovery in the labor market has been particularly strong. The unemployment rate remains low and has been steady at 3.6%, the lowest level since February 2020. The demand for labor, coupled with rising prices, continues to lead to wage pressure. From May 2021 to May 2022, the Consumer Price Index (CPI) spiked to 8.6%, the largest increase since December 1981.
During the quarter, the Federal Reserve intensified the magnitude of its interest rate increases. The most recent increase of 75 basis points is its most aggressive hike since 1994. Chairman Powell announced that he expects the July meeting to result in another increase of 50 or 75 basis points. He also indicated a much stronger path of rate increases ahead, to arrest inflation moving at its fastest pace in over 40 years.
The EIP Large Cap Value strategy outperformed its benchmark by 401 basis points, returning -8.20% gross of fees (-8.30% net of fees) during the quarter while the Russell 1000 Value Index declined -12.21%. The strategy is outperforming the index by 456 basis points gross (446 net) through the first half of 2022.
The portfolio benefited the most from security selection in Communication Services. It also had strong selection in Health Care, Financials and Industrials. The portfolio was also aided by an underweight allocation in Real Estate and an overweight in Consumer Staples. Security selection and an overweight allocation in Consumer Discretionary were the largest detractors from relative performance during the quarter.
Top 5 Performance Contributors
|Stock||Avg Weight %||Contribution %|
T appreciated following a Q1 earnings report that reduced concerns about the company’s free cash flow targets. The stock also rebounded from a prior period of weakness, related to the spin-off of Warner Brothers Discovery. We forecast better free cash flow for the upcoming Q2 earnings report, which is a catalyst for the stock. Valuation remains attractive, trading at an 8x P/E multiple and a 6% dividend yield, based on F2022 estimates.
MRK reported better than expected 1Q sales and profits. The sales strength came from key products including Keytruda and Gardacil. 2022 non-GAAP sales and EPS guidance were raised as well, despite a higher tax rate for the rest of the year. After the earnings report, management spoke at several conferences and the tone remained upbeat. We continue to like the stock as it has a compelling strategy to sustain its lead in oncology while its animal and vaccine franchises continue to grow. Lastly, management has been clear that business development is a high priority as Keytruda loses exclusivity later in the decade. Towards the end of 2Q, the Wall Street Journal reported that Merck may be interested in acquiring Seattle Genomics (SGEN), Inc, which is just the rumor that appeared to get the stock moving higher.
KMB rallied sharply after its Q1 earnings release. Sentiment was extremely low heading into earnings, but KMB surprised on the upside with 10% organic sales growth and a shift toward its higher-margin products. We exited the position shortly after the stock jumped as a highly inflationary environment remains concerning. Another concern with KMB is that the stock tends to sell off when input costs increase, mainly natural gas and pulp.
Top 5 Performance Detractors
|Stock||Avg Weight %||Contribution %|
|DuPont de Nemours||3.57||-0.86|
General Motors (GM)
GM’s underperformance in the second quarter continues to be driven by macro concerns regarding a recession. We note that the company’s fundamental performance remains exceptionally strong, and this quarter Cruise commercially launched its driverless ride-share business in San Francisco. Orders are very robust for the new lineup of EV’s, including the Hummer EV, Lyriq, and Silverado-E. GM had very strong production during the second quarter except for a late-quarter issue related to the chip-shortage that held up completion of 95,000 vehicles which will ship in the second half. So, while second quarter came in below street expectations, GM confirmed full-year guidance including an impressive 25-30% growth in year-on-year production.
Cisco Systems (CSCO)
CSCO declined during the quarter after reporting weaker fiscal Q3 results in May, as supply chain disruptions reduced revenue and worries mounted about difficult order growth comparisons in the upcoming quarter. Cisco reported 13% order growth in FQ3, slowing from over 30% in the previous three quarters, and now faces a year-over-year comparison against 31% order growth in FQ4. While execution on supply chain is disappointing, Cisco has built a large backlog, equivalent to two entire quarters of revenue, which should insulate results against weakening demand. Valuation remains very attractive at 12x our F2023 EPS estimate and we should see multiple accretion from the company’s increase in recurring revenue.
DuPont de Nemours (DD)
DD detracted from performance as its exposure to China and the semiconductor supply chain spooked investors. We believe DD continues to execute in an effective manner: selling off both non-core and high volatility assets, reducing overhead, smart M&A, and prioritizing share repurchasing. Management has hinted at legal settlements around their PFAS exposure, but nothing has materialized. We remain patient, as street numbers do not yet reflect DD’s recent accretive acquisition and sentiment remains negative.
as of June 30, 2022*
|QTD||1 Yr||3 Yr||5 Yr||7 Yr||10 Yr||Since Inception* *|
|Russell 1000 Value||-12.21%||-6.82%||6.86%||7.16%||7.68%||10.49%||6.31%|
Calendar Year Performance
|Russell 1000 Value||-12.86%||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: 1/1/07
Top 10 Holdings
|Goldman Sachs Group||5.12%|
|Pioneer Natural Resources||3.53%|
|Merck & Co||3.52%|
|Dupont De Nemours||3.35%|
Total Effect Attribution vs Russell 1000 Value
We remain optimistic about the portfolio as we head into the second half of the year. The market environment remains challenging, which we believe favors our investment approach. Our fundamental, bottom-up, predictive research process and philosophy is well suited for this environment. The market is reacting to company specific catalysts and events again, and our tenured team does a great job identifying those catalysts that will lead to a price increase. Another tailwind is the market rotation out of Growth and into Value. We have discussed the cap in P/E multiples between Growth and Value before, and that gap has closed significantly thus far in 2022. In January, the gap was approximately 14x, but that is now down to just under 7x.
We look forward to speaking with you on our quarterly calls. Our office is always open and we hope to see many of you in person this year. As always, we appreciate your commitment to Easterly Investment Partners.
The information provided in this report should not be considered a recommendation or solicitation to purchase or sell any particular security or investment strategy. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed do not represent an account’s entire portfolio and, in the aggregate, may represent only a small percentage of an account’s portfolio holdings. It should not be assumed that any of the securities transactions or holdings discussed was or will prove to be profitable, or that the investment recommendations or decisions the subadvisor makes in the future will be profitable or will equal the investment performance of the securities discussed herein. As a reminder investment return and principal value will fluctuate.
All information in this presentation has been obtained from sources believed to be reliable but cannot be guaranteed. There can be no assurance that the investment objective for this fund can be achieved and past performance is no guarantee of future results. The Russell 1000 Value Index® is a benchmark of unmanaged securities, and the index is not a security that can be purchased or sold.
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