Ariel Focus Fund commentary for the second quarter ended June 30, 2015.
For most of the second quarter, stocks were up fairly nicely at home and abroad—until the final few sessions. As news out of Puerto Rico and especially Greece worsened, stocks fell sharply. In the last two trading days of the quarter, the foreign stock MSCI EAFE Index dropped -2.97%, the U.S. large-cap S&P 500 Index fell -1.81%, and the U.S. small-cap Russell 2000 Index retreated -2.01%. To our minds, these sell-offs were not based on economic exposures but on an expansive sense of risk and, ultimately, on fear. The volatility extended to other asset classes: long U.S. bonds were up roughly +1.5% while high-yield bonds were off about -0.5% in those two days. Altogether, it meant most major stock indexes we track had roughly flat returns.
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This quarter, Ariel Focus Fund fell -0.80%, behind the Russell 1000 Value Index’s +0.11% gain, as well as the +0.28% gain of the S&P 500 Index.
Ariel Focus Fun: Performance contributors
Some of our holdings had good returns for the quarter. Toolmaker Stanley Black & Decker, Inc. (SWK) jumped +10.92% due to strong earnings. The market expected the company to earn $0.95 per share, while it managed to make $1.07. Revenues, gross margins and operating margins all advanced. We continue to see the company as having and nicely defending a good competitive position. In addition, investment bank Goldman Sachs rose +11.42%, as it continued to be in a good spot. It did not have any particularly surprising news, but as the market advanced, big financial firms strongly outperformed. The market continues to see Goldman as one of the top leaders in the broad industry, and we agree with that sentiment.
Ariel Focus Fun: Performance detractors
Other holdings slid in the volatile three-month period. Defense and aeronautics company Lockheed Martin fell -7.68%, despite an earnings beat. Specifically, the company announced earnings of $2.74 per share; the Wall Street estimate had been $2.50. Revenues were actually a bit short of expectations, so the market took the stock down a bit, given its relatively full valuation. We continue to see it as a very high-quality enterprise with a strong competitive advantage. Also, natural gas explorer Chesapeake Energy declined -20.65% as clouds continued to hang over the stock. The price of natural gas has declined nearly 40% over the past 12 months, and Chesapeake has become a favorite for short sellers as short interest has nearly quadrupled in just more than six months. Declines in prices for both natural gas and crude oil have brought increased scrutiny to Chesapeake debt level. We continue to own the stock.
During the quarter, we did not initiate any new positions nor did we eliminate any holdings in Ariel Focus Fund.
As we write, markets are particularly volatile, so there is no telling which way things will turn. We could see the current turmoil transform into a one- or two-week blip or the beginning of a more extended slide. As we have noted before many times, we think nobody can time the market with any reasonable consistency. So we have no special insight into where stocks are heading the rest of this month or quarter or even year. We do, however, have a fairly strong point of view that markets are overreacting. To be sure, the response is more muted than in 2011 and 2012, when there were reasonable worries about contagion. But at this point, the possibility of Greece exiting the European Union or Puerto Rico defaulting on its bonds has been very well-signaled and appropriately contained in advance. We do not think either entity has the power to disrupt the global economy, especially the U.S. economy. Therefore, if the market follows fundamentals, we think a fairly quick recovery is in order.