“The Fund companies have competitive advantages that, in our view, will generate durable growth over our investment time horizon. While these companies are not immune to the factors creating greater uncertainty, we believe their absolute and relative rates of profit growth should prove resilient in the current environment.” -Jennison Associates LLC
Market in Review
The investment environment at the start of 2022 was clouded by uncertainties related to COVID-19, inflation, and the prospect of slowing growth on the back of the Federal Reserve’s (Fed) plans for policy tightening. The military conflict in Ukraine added a dangerous new dimension of uncertainty in late February. The immediate reaction was a further ratcheting down of risk tolerance, as investors began to weigh the potential effects on European growth and the global ramifications of the most provocative conflict in Europe since WWII.
The Fed raised the federal funds rate for the first time since 2018 and indicated a commitment to tighten policy until inflation returns to the target range. The yield on the 10-year U.S. Treasury note finished the quarter at 2.3%—up approximately 80 basis points from year-end 2021—and a flattening yield curve suggested rising concerns about a potential recession. U.S. equities recovered strongly to end March in positive territory, though still meaningfully down meaningfully for the quarter. Higher-growth and higher-valuation companies were relatively poor performers throughout the period.
The S&P 500 Index and our benchmark, the Russell 1000® Growth Index, posted negative quarterly returns for the first time since the initial pandemic sell-off two years ago. The nearly 10% quarterly decline in the growth index occurred largely in January, reflecting a continuation of the market’s fourth-quarter adjustment to the Fed’s new policy-tightening roadmap. The result was further multiple compression for long-duration growth stocks in the Information Technology and Communication Services sectors, where the Harbor Capital Appreciation Fund (Institutional Class, “Fund”) had significant exposure.
Portfolio Performance
During the first quarter of 2022, the Harbor Capital Appreciation Fund (Institutional Class) returned -13.60%, underperforming the Russell 1000® Growth Index, which returned -9.04%, and the S&P 500 Index, which returned -4.60%. All sectors in the index were negative for the period, except Energy, which surged as oil prices rose dramatically on the back of escalating events in Ukraine.
The Fund’s stock selection in the Information Technology and Communication Services sectors detracted the most from relative return, but stock selection in the Consumer Discretionary sector benefited relative results.
Contributors & Detractors
CrowdStrike (CRWD, Financial) contributed to Fund returns during the quarter, benefiting from positive sentiment around the cybersecurity group as the frequency and severity of cyberattacks increased, and M&A started to pick up in the space.
Tesla (TSLA, Financial) delivered a positive return during the quarter, outperforming the benchmark significantly on the back of the long-awaited opening of its Berlin assembly plant, as well as rumors of another stock split.
Shopify (SHOP, Financial) declined during the quarter as investors reacted to the company confirming that its cash flow would be channeled into investments in growing the business, for the foreseeable future.
Netflix’s (NFLX, Financial) stock price was challenged after it offered guidance for new subscribers during the first quarter that disappointed investors.
Buys & Sells
We added Broadcom (AVGO, Financial) to the Fund on weakness during the quarter. It rebounded strongly, following an earnings beat and expectations of continued strength in demand.
We also initiated a position in Schlumberger (SLB, Financial), one of the world’s largest oil services companies, because the favorable supply-demand dynamics in the Energy sector and recent geopolitical developments are likely to lead to strong demand for Schlumberger’s services, particularly from the Middle East.
We exited Block (SQ, Financial) on the back of concerns around the company’s growth trajectory and a deceleration in key growth areas of the business.
We sold our position in PayPal (PYPL, Financial), reflecting concerns about the company’s growth strategy and profitability outlook.
Outlook
The economic and geopolitical backdrop is creating significant uncertainty for policymakers and investors. The Fed’s plans to raise short-term interest rates meaningfully this year and the ongoing crisis in Ukraine are contributing to elevated risk aversion and dampening expectations for global growth, since with a recession in Europe this year is now considered a real possibility. Meanwhile, the Omicron variant is forcing another round of lockdowns across China, with no clear path to near-term containment.
The Fund holds no Russian-listed securities. Revenues from Europe, however, are important to the global companies in the Fund, and we are monitoring trends there on a company-by-company basis.
The U.S. economy remains healthy and should continue to generate stronger growth than other developed regions. However, with interest rates moving higher to combat persistent inflationary pressures, the pace of U.S. growth is set to moderate. Our forecast for 2022 suggests a meaningful moderation in U.S. profit growth following last year’s dynamic rebound from the worst effects of the pandemic. We also anticipate a passing of the baton from outsized demand for goods to services, particularly travel and leisure spending.
The Fund companies have competitive advantages that, in our view, will generate durable growth over our investment time horizon. While the companies are not immune to the factors creating greater uncertainty, we believe their absolute and relative rates of profit growth should prove resilient in the current environment. Fundamentally, we are seeing little impact from higher interest rates and the conflict in Ukraine beyond what has been factored into our expectations, and we have consequently made few adjustments to positions. We acknowledge that elevated uncertainty, while weighing on valuations in the short term, can also have real effects on growth prospects over the longer term, and we will continue to adjust as needed, based on our fundamental analysis.
Performance data shown represents past performance and is no guarantee of future results. Past performance is net of management fees and expenses and reflects reinvested dividends and distributions. Past performance reflects the beneficial effect of any expense waivers or reimbursements, without which returns would have been lower. Investment returns and principal value will fluctuate and when redeemed may be worth more or less than their original cost. Returns for periods less than one year are not annualized. Current performance may be higher or lower and is available through the most recent month end at harborcapital.com or by calling 800-422-1050.
Views expressed herein are drawn from commentary provided to Harbor by the subadviser and may not be reflective of their current opinions or future actions, are subject to change without prior notice, and should not be considered investment advice.
The views expressed herein may not be reflective of current opinions, are subject to change without prior notice, and should not be considered investment advice.
This information should not be considered as a recommendation to purchase or sell a particular security. The weightings, holdings, industries, sectors, countries, and returns mentioned may change at any time and may not represent current or future investments.
