“We expect greater clarity around the path of inflation, growth, and interest rates to emerge in the first half of 2023, accompanied by a bottoming in earnings expectations and sentiment.” -Jennison Associates, LLC
Market in Review
Equity markets finished out a challenging year, with major indices closing at or near their lows for the year. An evolving economic slowdown—around the world and across industries—saw a broad swath of companies that had benefited most from the pandemic begin to reduce headcounts and take operational steps to mitigate expected weakness. Commodity prices continued their retreat, despite the lingering impact of the Ukrainian war. China took steps to ease its stifling zero-COVID-19 policy, resulting in a wave of infections, hospitalizations, and further economic dislocation as the year ended.
Economic data intra-quarter continued to reflect the mix of contrasting trends, with strength in employment, wages, and savings largely offsetting the effects of consumer price inflation, falling home prices, and waning spending by lower-income households. The persistence of labor market tightness kept the Federal Reserve (“Fed”) on a tightening path, with the federal funds rate closing the year in the range of 4.25%−4.50%—levels last seen in 2007. Inflation has been a global phenomenon, and central banks in many countries have followed a path similar to that of the Fed, leading to a partial retracement of the U.S. dollar’s significant rise since the end of 2021.
Growth equities have gone through a grinding period of adjustment over the past 15 months. The starting point for the correction also coincided with high levels of absolute and relative valuations for growth stocks, resulting in significant underperformance. Over the course of the past year, we made changes to the Harbor Capital Appreciation Fund (Institutional Class, “Fund”) that reflect the evolving investment climate and our outlook for earnings growth. We reduced exposure to smaller, less profitable companies in favor of businesses with experience navigating rapidly changing economic environments, as well as select health care opportunities, which do not correlate with the economic cycle to a large degree.
Portfolio Performance
During the fourth quarter of 2022, the Harbor Capital Appreciation Fund (Institutional Class) returned -1.49%, underperforming its benchmarks, the Russell 1000® Growth Index, which returned 2.20%, and the S&P 500 Index, which returned 7.56%.
Among the benchmark’s largest sectors, Health Care and Information Technology outperformed the broad index, while Communication Services and Consumer Discretionary underperformed.
The Fund underperformed the benchmark during the period. An overweight allocation to Consumer Discretionary and an underweight allocation to Industrials, along with stock selection within the Industrials and Consumer Staples sectors, detracted the most from the Fund’s relative performance. Stock selection within the Energy and Information Technology sectors benefited relative results.
Contributors & Detractors
Schlumberger (SLB, Financial) contributed to Fund returns, surging in the quarter on strong fundamentals and results ahead of expectations.
LVMH (XPAR:MC, Financial) also contributed, posting impressive growth and profitability—on the back of its less economically sensitive customer base—and pricing power reflective of the company’s strong brand positioning.
Tesla (TSLA, Financial) detracted from Fund returns, with the share price under pressure, as Elon Musk’s acquisition of Twitter and the subsequent controversy around his day-to-day involvement as CEO of that company weighed on Tesla’s valuation.
Atlassian (TEAM, Financial) also detracted from Fund performance, as its latest quarterly earnings report was disappointing concerning revenues and margins and weighed on its stock price.
Buys & Sells
We initiated a position in Thermo Fisher Scientific (TMO, Financial), a company that has become a leading supplier to a number of the most promising growth areas in research, diagnostics, and drug development.
We exited the position in Target (TGT, Financial) after concluding that the inventory issues that arose in 2022, along with increasing pressure on demand, particularly among lower-income consumers, will weigh on the company’s results for the foreseeable future.
Outlook
Investors are grappling with the likelihood of recession in the United States and around the world. The ongoing war in Ukraine and frequently changing pandemic policies in China remain unquantifiable risks. Persistent high inflation, resulting from the accommodative policies of the pandemic, has brought about a sharp reversal in monetary policy globally and an unusually abrupt tightening of financial conditions.
Over the course of the past year, we made changes to the Fund that reflect the evolving investment climate and our outlook for earnings growth. We reduced exposure to smaller, less profitable companies in favor of businesses with experience navigating rapidly changing economic environments, as well as select health care opportunities, which do not correlate with the economic cycle to a large degree. This is similar to our positioning during the 2008–2009 recession. That said, there are significant differences between the two periods, and while the current environment is uncertain, we do not anticipate the systemic risks that defined the global financial crisis.
It has been more than a year since the Fed announced its policy-tightening plans, and the market has adjusted to the new reality through sharply higher interest rates, lower growth expectations, and significantly lower stock prices and valuations. We expect greater clarity around the path of inflation, growth, and interest rates to emerge in the first half of 2023, accompanied by a bottoming in earnings expectations and sentiment. Our positive, multiyear view on our holdings incorporates the challenges that may continue to pressure the market in the short term.
Views expressed herein are drawn from commentary provided to Harbor by the subadvisor 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.
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.
