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 Snow All Cap Value strategy returned -14.11% gross of fees (-14.28 net of fees) during the quarter while the Russell 3000 Value Index declined -12.41%. The strategy is still outperforming the index by 23 basis points (6 net) through the first half of 2022.
Security selection within Consumer Discretionary and Communication Services were large detractors from performance. From an allocation perspective, an overweight position in Financials along with underweight allocations in both Health Care and Consumer Staples were the largest detractors. Energy and Information Technology added the most relative performance from a security selection perspective, while an overweight allocation to Energy also added value.
Top 5 Performance Contributors
|Stock||Avg Weight %||Contribution %|
|Silicon Motion Technology||1.81||0.31|
|Delek US Holdings||1.76||0.17|
Lamb Weston Holdings (LW)
LW appreciated following a robust quarterly report, which indicated improving demand levels for the company’s potato products and a better-than-expected gross margin outlook. LW is facing an industry-wide problem of a poor potato crop, however the company has taken several initiatives to control costs and pass along price increases.
VST performed well during a volatile quarter for major indices. Utilities across the board outperformed, but VST showed further relative strength as the company executed on their green energy initiatives and their shareholder friendly capital allocation plans. After significant appreciation in the stock, we sold VST to redeploy the capital in investments with more favorable risk/reward profiles.
Marathon Petroleum (MPC)
MPC outperformed during the quarter as demand for refined products has come at a time where there is a mismatch with supply. Despite higher prices for gasoline and diesel, demand will likely remain strong as China reopens from lockdowns and global inventories remain low. With a strong balance sheet and capital return policy, MPC provides an attractive way to benefit from the supply/demand imbalance in petroleum based refined products. We liquidated the position in order to invest the proceeds in an opportunity with a more imminent catalyst.
Top 5 Performance Detractors
|Stock||Avg Weight %||Contribution %|
|Lions Gate Entertainment||2.09||-1.09|
|American Eagle Outfitters||2.95||-1.08|
Lions Gate Entertainment (LGF/A)
LGF detracted from performance during the quarter as larger streaming peers NFLX and DIS pulled back, and operating income compressed due to outsized spending on growing the international streaming and studio businesses. The company is currently exploring potential alternatives for their STARZ business, which could include a spin or sale, with management citing recent transaction multiples in the media space as evidence that the stock price is not reflective of the value of their underlying assets. On a sum-of-the-parts basis, we see significant value to be unlocked.
American Eagle Outfitters (AEO)
AEO underperformed, along with several Consumer Discretionary stocks, as inflationary pressures, most notably rising gasoline prices, weighed on consumer demand. AEO and peers issued lower outlooks for the remainder of the year. The company expects high inventory levels to pressure gross margins throughout the year. We continue to hold AEO; efforts to rebalance inventory are well underway, the company has a clean balance sheet, and shares trade for just under nine times forward earnings.
JetBlue Airways (JBLU)
JBLU declined during the quarter after continued capacity (flight) cuts and costs-per-seat-mile that exceeded expectations. The airline industry in general has struggled to service flights as demand has ramped and JBLU’s material exposure to busy New York and Florida corridors have hurt them to an outsized degree. JBLU made a well-publicized bid for Spirit Airlines (SAVE) during the quarter, countering Frontier’s (ULCC) original bid for the company, which we view as an attempt for the company to acquire both pilots and planes at an expeditious pace. The portfolio exited the position early in the third quarter as continued execution missteps weighed on our thesis.
as of June 30, 2022*
|6/30/2022||QTD||1 Yr||3 Yr||5 Yr||7 Yr||10 Yr||Since Inception* *|
|Russell 3000 Value2||-12.41%||-7.46%||6.81%||7.00%||7.59%||10.39%||9.59%|
Calendar Year Performance
|Russell 3000 Value2||-13.15%||25.37%||2.87%||26.26%||-8.58%||13.19%||18.40%||-4.13%||12.70%||32.69%|
Source: SEI Global Services
* Returns for periods greater than a year are annualized. Past performance is not indicative of future results.
** Inception: 1/1/1992
Top 10 Holdings
|Commercial Metals Co.||3.43%|
|JPMorgan Chase & Co.||3.18%|
|Hartford Financial Services Group||3.08%|
|Marathon Petroleum Corp.||3.08%|
|Lincoln National Corp.||2.96%|
|Coterra Energy Inc.||2.91%|
|Bank of America Corp.||2.87%|
Total Effect Attribution vs Russell 3000 Value
We continue to be optimistic about the long-term outlook for the portfolio. While low P/E stocks performed relatively well for the first six-months of 2022, large valuation disparities remain. In turn, we expect value to continue to outpace growth over the coming quarters.
Given the market backdrop, we continue to hold a large allocation to the Financials sector. This sector has historically been among the most sensitive to changes in interest rates. Within Financials, banking stocks have been hit, as concerns about the economy have grown and they continue to trade at steep valuation discounts relative to the broader market.
Even if the economy is recession bound, banks are better equipped to handle economic shocks than they were in the past. As a group, banking stocks have a more attractive balance of risk and reward than any other sector. Banks also generally benefit from higher rates, as they can increase profit margins from the spread between deposits and loans. At the same time, many of these companies could drive significant shareholder value in the form of dividends and share repurchases. Our focus within the sector is on those firms that are well capitalized, with strong credit quality and the ability to grow net interest margins, as well as market share.
Energy has been the only positive returning sector within the Russell 3000 Value Index this year. With the U.S economy slowing, many investors expect a cyclical pullback in commodity markets. Consumers are becoming more cautious of a slowing economy and higher inflation. Many believe that these factors will inhibit the Energy sector to continue its strong run. In contrast, we expect further equity appreciation in the Energy sector. There is a secular upward trend in demand for petroleum-based products and supply shortages created by global refining products, tightening that will likely persist through 2023.
Further contributing to the Energy sector is a decrease in the number of refineries within the U.S. America has lost in excess of one million barrels of daily refining capacity over the course of the last two years, and at least seven facilities have closed. This decreased refining production has led to an imbalance between supply of crude oil and U.S. refining capacity. Crude oil has no utilitarian value until a refiner processes it into fuels such as gasoline, diesel and jet fuel. The overall pricing difference between a barrel of crude oil and the products refined from it, is called a “crack spread.” Currently, widening crack spreads within the U.S are increasing the price of petroleum-based fuels. Despite higher prices for gasoline and diesel, demand will likely remain strong, supporting stocks within the Energy sector. Although U.S. crack spreads are mainly impacted by national refineries, global affairs continue to put pressures on supply and demand of crude oil. Crack spreads expanded further as the impact of Russian sanctions translated into even lower refined product supply. All things considered, we believe several of our positions within the Energy sector will benefit from this dynamic.
We believe the road ahead remains favorable for our investment approach. The stocks in our portfolio have compelling business fundamentals, strong balance sheets, 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.
All told, we remain dedicated to delivering strong long-term performance and transparent communications to our shareholders. As always, thank you for your commitment to Easterly Investment Partners.
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 Snow Capital Management All Cap Value Equity Composite contains fully discretionary all cap value equity accounts and for comparison purposes is measured against the S&P 500 and Russell 3000 Value indices. Beginning July 1, 2005, there is no account minimum for this composite. Prior to July 1, 2005, the minimum account size for this composite was $200 thousand. Prior to October 1, 2002, the minimum account size was $300 thousand and prior to January 1, 2000, the minimum account size was $100 thousand. On January 1, 2008, the benchmark was changed retroactively from the Russell 3000 to the Russell 3000 Value to better reflect the All Cap Value Equity investment strategy. 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. 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 3000® Value Index
The Russell 3000 Value Index measures the performance of the broad value segment of U.S. equity value universe. It includes those Russell 3000 companies with lower price-to-book ratios and lower forecasted growth values. Indexes are unmanaged. It is not possible to invest directly in an index.