It was a strong first quarter for equities. Foreign stocks led the way with a +7.25% gain, with large-cap U.S. stocks rising +6.07% and small-caps advancing +2.47%. The ebullience beginning with the November presidential election continued for the first two months of 2017. In March, however, international stocks kept charging while U.S. stocks went flat. And so, this quarter, both foreign and U.S. shares appear to have hit low-key inflection points. Just three months ago we wrote about the international bear market, which started in 2014. That downturn may well have ended; the MSCI EAFE Index is now up roughly +10% since mid-November. For domestic stocks, we think the plateau in March was most likely a measured response to the Federal Reserve’s quarter-point rate hike mid-month. To date, nobody knows whether the sideways move was a pause or a lasting deceleration. This quarter, Ariel Fund gained +6.56%, trouncing the Russell 2500 Value Index’s +1.62% move as well as the +3.76% rise of the Russell 2500 Index.
Some stocks in the portfolio performed quite well. Media company Viacom, Inc. (VIAB) leapt +33.44% as new CEO Bob Bakish began to implement his vision. In early February, as the company announced earnings per share of $1.04 versus the $ 0.83 consensus, Bakish introduced his five-point strategy. We especially like his decision to emphasize six flagship brands: BET, Comedy Central, MTV, Nickelodeon, Nick Jr., and Paramount. A week later he underscored this point when he asked the CEO of underperforming Paramount to step down. We think focusing on what matters most is smart—and especially important at a complex, intricate organization such as Viacom. In addition, cutting tools maker Kennametal Inc. (KMT, Financial) surged +26.15% on solid guidance and the assumption it could benefit from a new U.S. trade policy. During the quarter, the company announced revenues would improve this year, allowing it to pare back cost-cutting. Meanwhile, Wall Street and some prominent hedge funds became more bullish on Kennametal because its overseas competitors, Iscar and Sandvik, would be hurt if U.S. trade policy became more protectionist. We admire the firm not for short- term tailwinds but for its strong positioning in a small but crucial niche business.
Other holdings in the portfolio underperformed. Helicopter transport company supplier Bristow Group Inc. (BRS, Financial) declined –25.41% in tandem with sinking oil prices. That said, the company actually surpassed the Street’s gloomy expectations, losing $0.28 per share rather than $0.48. The stock rose on that news, but declined over the course of the quarter as oil fell from the $55 range to below $ 50. As we have said before, the commodity’s price will rise and fall, yet oil is necessary to the world; therefore we firmly believe companies will continue to need Bristow’s services. Also, corporate credit expert Dun & Bradstreet Corp. (DNB, Financial) fell –10.62% after issuing disappointing guidance. During a mixed quarterly earnings report, the firm guided toward 1% to 3% revenue growth for 2017; Wall Street had long expected 5% growth this year. A key reason for the disappointment is the restructuring of the firm’s relationship with Salesforce.com, which will likely crimp near term growth. While recent growth has been slower than management or its investors would prefer, we think Dun & Bradstreet is well-positioned for the long term.
We did not purchase any new positions, nor did we eliminate any positions in Ariel Fund in the first quarter of the year.
Entering the year we discussed our ongoing optimism and rising caution. That is, the economy continues to be in good shape: inflation and unemployment are low, while growth continues. Short- term interest rates have moved from zero to positive yet low; we think a return to more normal rates is good for the economy. That said, we continue to be wary of current U.S. market valuation levels. The S&P 500 Index recently traded at 18X forward earnings while the Russell 2000 Index was nearly 24X. These figures are above average, although not in what we consider dangerous territory. Broadly, valuations are lower outside the United States; the MSCI EAFE now trades at just 15X forward earnings. Elevated U.S. valuations come at an interesting time given the recent fanfare over passive investing’s prowess. We think markets trading at high valuations can pose problems for passive investors. That is, they accept valuation as a given, suffering losses when valuations contract. On the other hand, active managers can put together a portfolio of stocks with lower valuation levels, which might help them sidestep some of the damage when broad valuation levels come down.
This commentary candidly discusses a number of individual companies. These opinions are current as of the date of this commentary but are subject to change. The information provided in this commentary does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security.
As of 3/31/17, Viacom, Inc. constituted 3.0% of Ariel Fund; Kennametal Inc. 3.3%; Bristow Group Inc. 2.1%; and Dun & Bradstreet Corp. 2.1%. Portfolio holdings are subject to change. The performance of any single portfolio holding is no indication of the performance of other portfolio holdings of Ariel Fund.
