Market Summary
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.
Performance Highlights
The Snow Focused Value strategy outperformed its benchmark by 108 basis points, returning -11.13% gross of fees (-11.34% net of fees) during the quarter, while the Russell 1000 Value Index declined -12.21%. The strategy is outperforming the index by 217 basis points (196 net) through the first half of 2022.
The portfolio benefited from security selection in Energy, Consumer Staples, and Financials. The portfolio was also aided by an underweight allocation in Materials and an overweight allocation in Energy. Security selection in Communication Services and Consumer Discretionary, along with an underweight allocation in Utilities, were the largest detractors from relative performance during the quarter.
Portfolio Attribution
Top 5 Performance Contributors
| Stock | Avg Weight % | Contribution % |
|---|---|---|
| Lamb Weston Holdings | 5.27 | 0.88 |
| Marathon Petroleum | 0.89 | 0.24 |
| Coterra Energy | 6.61 | 0.21 |
| HF Sinclair | 2.89 | 0.18 |
| Molson Coors Beverage | 3.83 | 0.14 |
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.
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
Coterra Energy (CTRA)
Despite a volatile quarter for oil and gas prices, shares of CTRA positively contributed to performance as we tactically managed the position size. With a clean balance sheet and modest production growth plans, CTRA is expected to generate significant free cash flow.
Top 5 Performance Detractors
| Stock | Avg Weight % | Contribution % |
|---|---|---|
| Lions Gate Entertainment | 2.93 | -1.55 |
| Walt Disney | 3.59 | -1.3 |
| PVH | 3.61 | -1.06 |
| American Eagle | 2.56 | -0.95 |
| Intel Corp | 3.61 | -0.92 |
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.
The Walt Disney Company (DIS)
DIS pulled back during the quarter as costs and losses continue to build in the direct-to-consumer segment of the company. The firm continues to build the streaming platform globally, which includes Disney+, ESPN+ and Hulu. We believe the short-term costs to build out the streaming platform are prudent. In our view, the company’s brand strength and diversified cash flow streams from their parks and consumer products lines differentiates DIS from pure-play streaming companies.
PVH (PVH)
PVH underperformed along with several Consumer Discretionary stocks as inflationary pressures, most notably rising gasoline prices, weighed on 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 in China, a multi-year strategy to accelerate growth, and a recently announced repurchase authorization. We continue to find PVH shares attractive, trading for approximately six and a half times forward earnings estimates.
Trailing Performance
as of June 30, 2022*
| QTD | 1 Yr | 3 Yr | 5 Yr | 7 Yr | 10 Yr | Since Inception* * | |
|---|---|---|---|---|---|---|---|
| Composite (Gross) | -11.13% | -4.58% | 10.57% | 7.08% | 4.96% | 10.64% | 13.62% |
| Composite (Net) | -11.34% | -5.50% | 9.49% | 6.04% | 3.93% | 9.59% | 12.61% |
| Russell 1000 Value | -12.21% | -6.82% | 6.86% | 7.16% | 7.68% | 10.49% | 11.14% |
Calendar Year Performance
| 2022 | 2021 | 2020 | 2019 | 2018 | 2017 | 2016 | 2015 | 2014 | 2013 | |
|---|---|---|---|---|---|---|---|---|---|---|
| Composite (Gross) | -10.69% | 31.80% | 2.57% | 28.00% | -18.03% | 17.76% | 15.10% | -18.20% | 15.17% | 50.18% |
| Composite (Net) | -11.12% | 30.54% | 1.53% | 26.81% | -18.87% | 16.61% | 13.97% | -19.03% | 14.02% | 49.10% |
| 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: 12/31/08
Top 10 Holdings
| Lamb Weston Holdings Inc. | 6.35% |
| Centene Corp. | 5.95% |
| Coterra Energy Inc. | 5.19% |
| Amgen Inc. | 5.01% |
| Cardinal Health Inc. | 4.84% |
| Hartford Financial Services Group | 4.74% |
| MetLife Inc. | 4.61% |
| Molson Coors Beverage Co. | 4.40% |
| Suncor Energy Inc. | 4.40% |
| HF Sinclair Corp | 4.27% |
| Total | 49.74% |
|---|
Total Effect Attribution vs Russell 1000 Value
Outlook
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 1000 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.
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. 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.