Clearbridge Value Trust commentary for the fourth quarter 2014.
Clearbridge Value Trust: Market overview
Major indices closed the year with strong gains in the fourth quarter, despite elevated volatility. The market sold off sharply in the first half of October as investors focused on global growth concerns and tumbling crude oil prices. The International Monetary Fund cut its outlook for global growth in 2015 and warned about the risks of rising geopolitical tensions and a financial-market correction as stocks reached “frothy” levels. Stocks rebounded, however, on the back of generally strong U.S. economic data, accommodative central bank headlines, several large M&A announcements, and strong quarterly corporate results. The S&P 500, Dow Jones and Nasdaq gained +4.9%, +5.2% and +5.8%, respectively, over the quarter. The small-cap Russell 2000, which sold off in the third quarter, surged +9.7%. The S&P was weighed by the energy sector, off -10.7%, and telecoms, down -4.2%. For the year, each major index posted double-digit returns, with the S&P and Nasdaq gaining +13.7% and +14.8%, respectively, trailed by the Dow, which added +10.0%. Small caps also lagged, up only +4.9% on the year. Within the S&P 500, the energy sector lost -7.8% and was the only group in the red, while health care, utilities and tech led the advancing sectors with gains between +20% and +30%.
Third-quarter GDP expanded at an annualized rate of 5.0%, marking the strongest pace since the third quarter of 2003 and reinforcing the second quarter’s 4.6% growth rate. Additionally, the Conference Board’s consumer confidence index spiked +6% in October to the highest reading since late 2007. The unemployment rate declined from 6.1% to 5.6% over the quarter and November posted the strongest jobs report in approximately three years as U.S. employers added 321,000 jobs. The number of jobs created over the year fell just short of three million, the highest since 1999. Finally, the Consumer Price Index was essentially stagnant throughout the quarter, indicating the Fed’s 2% inflation target is still well off into the future.
As most predicted, the Federal Reserve wrapped up its bond-buying program in October and maintained its plans to keep target rates near zero for a “considerable time.” Fed Chair Janet Yellen also voiced confidence in the U.S. economy despite concerns of a broader global slowdown. Later in the quarter, the S&P 500 saw its best two-day rally in three years after the Fed slightly altered its language by assuring the committee will be “patient” in raising target rates, widely considered consistent with their long-standing “considerable time” stance.
Overseas, accommodative announcements from central banks outweighed disappointing economic figures. GDP in the eurozone expanded by only 0.2% in the third quarter, while Japan’s GDP contracted -1.9%, driving the economy into a recession (following the -6.7% contraction in the second quarter). ECB President Mario Draghi unveiled plans for the central bank to purchase sovereign debt for at least two years and insisted that European lawmakers enact political reforms necessary to complement the ECB’s stimulus efforts amid the low-growth environment. Meanwhile, Japan’s central bank boosted its target for monetary stimulus by nearly 25%, to $724 billion, and China’s central bank cut lending rates for the first time in more than two years.
Crude oil futures slid throughout the quarter, dropping from about $90 per barrel to $50 per barrel, the lowest level since 2008. Both the Organization of Petroleum Exporting Countries (OPEC) and the International Energy Agency (IEA) cut their demand forecasts for 2015, while OPEC members refused to cut production to ease the global glut. Saudi Arabia also cut the price to its U.S. oil customers, reinforcing its plan to maintain market share rather than support prices. Meanwhile, U.S. oil companies announced plans to cut capital spending next year and suspend deep-water drilling activity.
Of the S&P 500’s constituents, 75% topped bottom-line expectations for the third quarter. Additionally, several retailers surprised the Street with an incrementally positive outlook for the holiday season, indicating that lower gas prices could be providing a tailwind for consumer spending. Meanwhile, management teams continued to take advantage of low borrowing rates, with several notable deals announced during the quarter. In two of the biggest deals of the year, Halliburton officially agreed to acquire peer oil services company Baker Hughes for $35 billion and Actavis agreed to pay nearly $66 billion for Botox-manufacturer Allergan, putting an end to Valeant Pharmaceuticals’ hostile takeover attempt. However, Abbvie reversed plans to acquire Ireland-based peer Shire for $54 billion following new measures from the U.S. Treasury aimed at making it harder for U.S. companies to merge with non-U.S. companies for tax-inversion purposes.
Clearbridge Value Trust Fund highlights
During the fourth quarter of 2014, the ClearBridge Value Trust – Class C shares generated a total return of 3.73% excluding sales charges. In comparison, the Fund’s unmanaged benchmark, the S&P 500 Index, returned 4.93% and the Lipper Large Cap Core Funds category average was 4.27% for the same period.
Using a three-factor performance attribution model,1 relative portfolio performance was driven by security selection effects, the interaction of sector allocation and security selection and sector allocation. In terms of sector allocation, an overweight position in energy and an underweight in consumer staples hurt relative performance, as the former sector underperformed the benchmark while the latter outperformed. United Continental, Yahoo!, Amgen, UnitedHealth Group and Lowe’s were the largest contributors to performance, while the biggest detractors included Apache, Genworth Financial, LyondellBasell Industries, Halliburton and CONSOL Energy.
During the fourth quarter we initiated six new positions: Perrigo, PulteGroup, EOG Resources, Realogy Holdings, Rockwell Automation and Keurig Green Mountain. Five positions were eliminated during the quarter: Southwestern Energy, Parker Hannifin, Capital One Financial, Celgene and Halliburton.
Clearbridge Value Trust: Top contributors
United Continental was among the top contributors in the portfolio over the past quarter largely due to the sharp decline in crude oil prices. Fuel accounts for anywhere between one-third and half of airlines’ operating costs, so the 32% decline in the price of jet fuel during the fourth quarter and steady ticket prices helped boost airline stocks during the period. We see greater upside in the stock as management implements several initiatives to improve margins and the overall industry becomes more disciplined on capacity management.
Yahoo! was a top contributor during the fourth quarter on the back of better-than-expected results for the third quarter and an accelerated share-buyback program for 2.4% of its shares outstanding. Revenue was better than expected, thanks to a smaller decline in display revenues, and EBITDA also topped expectations due to good cost discipline. We continue to like the stock at current levels and believe investors underappreciate the possibility of more tax-efficient divestitures of Yahoo!’s Asian assets while overestimating the odds that management will destroy value of proceeds from the Alibaba IPO through costly acquisitions.
Lowe’s climbed steadily throughout the final months of the year, gaining 30% as the company reported two successive quarters of better-than-expected earnings and offered a bullish outlook for 2015. We maintain a favorable outlook for the housing industry, as the economy has broadly recovered in terms of employment and GDP while the housing cycle has lagged. With low