Despite several bouts of geopolitical unrest, the S&P 500 Index gained +5.23% during the second quarter and has returned +7.14% since the beginning of the year. Equity investors appeared to largely dismiss both the Russia/Ukraine and Iraq/ISIS conflicts as economically inconsequential. In fact, the VIX Index, often used as a proxy for overall investor apprehension, reached a seven-year low in mid-June. Economic activity over the past quarter was positive and seems to have invigorated investor confidence. The unemployment rate fell to a post-financial crisis low, and now stands at 6.1% compared to 10.0% in late 2009. The housing market demonstrated signs of improvement, with new home sales reaching six-year highs and pending sales of existing homes reaching four-year highs. Corporate performance continued to be robust with more than 75% of S&P 500 Index companies exceeding consensus earnings estimates this quarter. In response to these developments, the Federal Open Market Committee’s official statement in mid-June struck a more optimistic tone than its late-April statement, which helped boost equity prices. With the VIX Index reaching a multi-year low, however, we would not be surprised to encounter stints of increased volatility in the near/medium term.
All S&P 500 sectors posted positive returns during the quarter, but dispersion between the best and worst performers was notable.
The energy sector led the way, more than doubling the S&P 500 Index return. The price of crude oil rose modestly amid renewed turmoil in Iraq. Financials and consumer discretionary stocks lagged, which is slightly unusual in a positive market environment given their pro-cyclical nature.
We believe the strong economic and corporate backdrop supports higher stock prices but increased valuations have tempered our expectations. The S&P 500 Index trades at 16.7x next year’s consensus earnings estimates, which is slightly above the 25-year median (16.0x). The Index trades at 2.6x book value, which is in line with the 25-year median. The portfolio, however, trades at 11x our estimate of normal earnings and 1.5x book value, which represents a considerable discount to the market. While higher price- to-earnings levels suggest equity prices may be getting ahead of earnings, interest rates remain near historic lows and we believe the risk premium to own equities versus bonds is still quite compelling.
The Hotchkis & Wiley Large Cap Value Fund (Class I) underperformed the Russell 1000 Value Index during the second quarter of 2014. Stock selection in technology was the largest performance detractor for the quarter. Oracle (ORCL) (2.7%)* lagged after reporting results slightly below consensus estimates, though our investment thesis remains fully intact. Stock selection in telecommunications also detracted from performance, as our lone position (Vodafone 3.0%*) lagged the market. Vodafone (VOD) reported modest results and a disappointing outlook due to elevated capital expenditures. Vodafone , Bank of America (BAC) (3.3%)*, and Target (TGT) (2.7%)* were the largest individual performance detractors. Positive stock selection in healthcare, energy, and utilities contributed to performance during the quarter. Royal Dutch Shell (RDS.A)(4.1%)*, NRG Energy (NRG) (1.7%)*, and American Int’l Group (AIG) (4.7%)* were the largest individual performance contributors.
*% of total portfolio as of June 30, 2014.
Mutual fund investing involves risk. Principal loss is possible. The Fund may invest in foreign securities which involve greater volatility and political, economic and currency risks and differences in accounting methods. The Fund may invest in American Depository Receipts (“ADRs”) and Global Depository Receipts (“GDRs”) which may be subject to some of the same risks as direct investment in foreign companies.
Fund holdings and/or sector allocations are subject to change and are not buy/sell recommendations. Current and future portfolio holdings are subject to risk. The opinions expressed are those of the portfolio managers as of 6/30/14 and may not be accurate reflections of their opinions after that date. There is no guarantee that any forecasts made will come to pass. The Fund may not continue to hold the securities mentioned and the Advisor has no obligation to disclose purchases or sales of these securities. Past performance is no guarantee of future results. Diversification does not assure a profit nor protect against loss in a declining market.