Hotchkis & Wiley's First Quarter Commentary: Optimistic Outlook Due to Corporate Fundamentals
MARKET COMMENTARY: The U.S. equity market delivered its best opening quarter since 1998, as the S&P 500 Index posted a 12.6% return. The market’s advance was prompted by continued signs of a strengthening U.S. economy and the absence of new negative global macroeconomic developments. Consequently, the VIX Index (i.e. the “Fear Index”) declined from well above its historical average at the beginning of the quarter, to well below its historical average at the end of the quarter. As short-term fears subsided and became a less prominent driver of investor behavior, we observed a shift in the market’s focus toward underlying fundamentals and valuations of individual stocks. This type of shift tends to reduce the correlation of returns across stocks and forms an environment conducive for bottom-up, fundamental value investors.
During the quarter, cyclical sectors outperformed non-cyclical sectors. Financials, technology, and consumer discretionary stocks were among the leaders while utilities, telecommunications, and energy stocks were among the laggards. The large cap growth indices outperformed large cap value indices, primarily due to the larger weight in the strong-performing technology sector. Large, mid, and small cap stocks performed similarly.
Going forward, we remain optimistic regarding the equity market’s prospects due to considerable fundamental improvements exhibited across the corporate sector. Despite modest economic growth, companies have generated robust earnings and cash flows, which have been predominately used to reduce debt. Valuations continue to be compelling even after this quarter’s appreciation. Also, we believe the market’s affection for Treasuries is likely to recede as real yields at/below zero will eventually erode the purchasing power of institutional and individual investors alike. The 30 basis point rise in 10-year Treasury yields over the first quarter may well be a harbinger of this cautionary message.
With the lingering sovereign debt issues in Europe and the uncertain growth prospects in emerging markets, we are prepared to combat bouts of elevated volatility in the near/medium-term. During these episodes, we have found that the changes in security prices (i.e. volatility) are often not commensurate with the changes in real risk. Our experience has shown us that focusing on corporate fundamentals is the most effective course when navigating erratic waters; we attempt to mitigate risk through sound valuation support and an exhaustive assessment of underlying company risks (excessive/hidden financial leverage, for example).
ATTRIBUTION: Q1 2012
The Hotchkis and Wiley Large Cap Diversified Value portfolio (gross and net of management fees) outperformed the Russell 1000 Value Index for the quarter. Positive stock selection in financials, consumer discretionary, and energy was the primary performance contributor for the quarter. Cobalt International Energy, Gap, and CA Technologies were the largest individual contributors. Stock selection in utilities, healthcare, and telecom was the primary performance detractor for the quarter. Hewlett-Packard, Royal Dutch Shell, and Exelon were the largest individual detractors.
The portfolio attribution in this commentary is based on a representative Large Cap Diversified Value portfolio. Certain client portfolio(s) may or may not contain the securities discussed in this commentary due to the account’s guideline restrictions, cash flow, tax and other relevant considerations. The commentary is for information purposes only and is not intended to be, and should not be, relied on for investment advice. The opinions expressed are those of the portfolio managers as of 3/31/12 and may not be accurate reflections of their opinions after that date. There is no guarantee that any forecasts made will come to pass. Accounts may not continue to hold the securities mentioned and H&W has no obligation to disclose purchases or sales of these securities. Past performance is no guarantee of future results.