MARKET REVIEW
U.S. equities markets were highly volatile, unsettled by U.S.-China trade discord, softening economic growth in the U.S., Europe, China, and geopolitical uncertainty.
Affected by tariffs, industrial, agricultural, and transportation sector activity deteriorated. New threats and escalating rhetoric caused growing concern, and companies across sectors cited trade tensions as the source of heightened caution in planning and investing. The U.S. political landscape was likewise unsettled, as investigations of interference in the 2016 presidential election unfolded, impeachment proceedings against President Trump began, and the 2020 election cycle ramped up.
U.S. economic activity showed signs of tempering, with job growth and business activity moderating. Modest wage gains and positive consumption indicated a still-healthy consumer, although consumer confidence showed signs of weakening.
Markets responded favorably as the U.S. Federal Reserve (Fed) pivoted on monetary policy, lowering the federal funds rate three times in the period to 1.50%-1.75% at the end of October.
Economic growth in Europe softened. The United Kingdom’s ongoing Brexit negotiations saw little headway toward resolution. Germany, Europe’s largest economy, stood on the brink of recession. China’s gross domestic product (GDP) grew close to the country’s 6% target but not without months of stimulating measures designed to mitigate the impact of the trade war with the U.S.
PERFORMANCE
Harbor Capital Appreciation Fund advanced 13.73% (Retirement Class), 13.63% (Institutional Class), 13.35% (Administrative Class), and 13.21% (Investor Class) in the fiscal year, while the Russell 1000® Growth Index rose 17.10%, and the broader market, as represented by the S&P 500
Index, climbed 14.33%.
In the growth benchmark, the Real Estate and Materials sectors made the biggest gains. Energy posted a double-digit decline. Among the benchmark’s major sectors, Information Technology outperformed the overall index, while Health Care, Industrials, Communication Services, and Consumer Discretionary underperformed.
Consumer Staples positions were solid positive contributors to Fund performance. Estée Lauder (EL, Financial) has enhanced its strong brand portfolio in the fast-growing luxury beauty care market with complementary acquisitions and subsequent brand development. Emerging markets, especially China, are key drivers of the company’s growth. Costco Wholesale’s (COST, Financial) consistent stream of membership fee income allows for low prices and broad product selection, which lead to high inventory turnover.
In Consumer Discretionary, fast casual restaurant company Chipotle’s (CMG, Financial) new management team is improving sales through new products, better marketing, mobile/digital efforts, and delivery. Lululemon Athletica’s (LULU, Financial) new products, integrated marketing, and online sales momentum combined with a high-end customer base and athleisure fashion trends are driving strong customer traffic, sales conversion, and comparable store sales. The company also has strong brand positioning, international prospects, margin-expansion opportunities, and attractive return on invested capital.
Communication Services positions advanced but lagged the benchmark sector. Despite ongoing concern about data privacy, Facebook (FB, Financial) is showing resilience, with solid engagement metrics and strong revenue growth, as advertisers continue to seek to use the platform to reach customers. Netflix (NFLX, Financial) continues to enhance its long-term competitive position with the industry’s largest commitment of investment dollars in exclusive and original content. The company’s domestic subscriber base decreased marginally in 2019’s second quarter, and international net subscriber additions reverted to 2016 levels. We attribute this downturn to the traditional seasonal weakness of the second quarter, the effect of the company’s highest-ever price increase in the first quarter, and a content slate lacking in exciting new titles. Given its still-low global penetration and the accelerating shift from linear TV, we believe Netflix still has significant room for growth. The Fund’s position in video game publisher Activision Blizzard (ATVI, Financial) was eliminated on slowing revenue growth.
Information Technology holdings in the aggregate posted a double-digit advance but underperformed the benchmark sector. Payments companies continue to benefit from the long-term shift from cash to electronic transactions. MasterCard (MA, Financial) and Visa (V, Financial) have, in our view, strong market positions with high barriers to entry, pricing power, and solid operating leverage potential. FleetCor (FLT, Financial) provides specific-purpose charge cards and payment-processing services for commercial and government trucking fleets and has a rapidly growing mobile payments business in Brazil. Digital payments platform provider Square (SQ, Financial) fell on disappointing financial results.
Digital transformation of the enterprise has become a strategic imperative across many industries and companies. Cloud holdings Microsoft (MSFT, Financial) and Workday (WDAY) offer mission-critical applications and services that are changing fundamentally the way businesses operate.
After strong performance through much of 2017 and 2018, Nvidia (NVDA) fell on gaming graphics microchip inventory issues exacerbated by a slowdown in the cryptocurrency mining boom. The company was also hurt by worries that U.S.-China trade discord could disrupt technology product markets, depressing chip demand. Trade and demand concerns affected Xilinx (XLNX) and Taiwan Semiconductor (TSM), as well.
Twilio’s (TWLO) cloud communications platform enables software developers to build, scale, and operate communications functions such as phone calls, text messages, video, and e-mail within their mobile applications through Twilio’s web-service application programming interfaces. Despite strong revenue, customer growth, and expansion rates, the stock lost ground as investor positive sentiment toward high-growth, and therefore higher valuation, software as a service companies weakened, affected by a highly uncertain macroeconomic backdrop.
OUTLOOK & STRATEGY
Driven by powerful secular trends, we expect the growing revenue streams of Fund companies in industries such as e-commerce, software as a service, and payments to be durable against the uncertain backdrop.
We continue to focus on companies that we believe have unique business models that build sustainable competitive advantages, catalysts that drive above-average growth rates, superior financial characteristics, and appropriate long-term valuations. Against this backdrop, in our view the Fund is well positioned with companies whose growth prospects remain robust and well above average.
This report contains the current opinions of Jennison Associates LLC as of the date of this report and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Such opinions are subject to change without notice and securities described herein may no longer be included in, or may at any time be removed from, the Fund’s portfolio. This report is distributed for informational purposes only. Information contained herein has been obtained from sources believed reliable, but not guaranteed.
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