Commentary
Large Cap Growth 2Q 2022
Markets Review
The U.S. equity market posted its second consecutive quarterly decline, as the S&P 500 Index fell -16.10% during the period, bringing its year-to-date return to -19.96%. The year-to-date performance marked the worst first half of a year since 1962. Concurrently, the Bloomberg U.S. Aggregate Bond Index dropped -4.69% for the quarter, bringing the year-to-date return to -10.35%. In terms of style, the Russell 1000 Value Index outperformed its growth counterpart by 8.71% during the quarter. For the first half of the year, that outperformance was 15.21%, on track to be the largest calendar year lead for value since the early 2000s.
Sources: SS&C Advent, Bloomberg
Past performance is not indicative of future results. Aristotle Atlantic Large Cap Growth Composite returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Aristotle Atlantic Composite returns are preliminary pending final account reconciliation. Please see important disclosures at the end of this document.
On a sector basis, all eleven sectors within the Russell 1000 Growth Index finished lower for the quarter, with Consumer Discretionary, Communication Services and Information Technology posting the largest declines. Meanwhile, Consumer Staples, Energy and Utilities declined the least.
Soaring inflation, combined with a 1.6% decrease in first quarter GDP and estimates for another decline in the second quarter, is increasing fears that a recession may be on the horizon. The CPI rose 8.6% for the year ended in May, and average U.S. gasoline prices (briefly) breached $5 per gallon in June for the first time in history. Consumers responded to the broad-based increase in prices by reducing their personal savings rate to 4.4% in April, the lowest level since September 2008. The negative effects of supply-chain disruptions also persist, and management teams have highlighted that the strengthening dollar has reduced demand for U.S. goods sold abroad.
In many ways, the economy has continued to show signs of strength. The labor market has remained tight, with unemployment at 3.6% in May, similar to previous cyclical lows. Companies again reported robust earnings, as S&P 500 constituents grew earnings 9%, year over year, with 77% of companies exceeding consensus EPS estimates.
In response to elevated inflation, in May, the Federal Reserve raised the federal funds rate 0.50%. In June, it raised rates an additional 0.75%, the largest increase since 1994, moving the benchmark rate to a range of 1.50% to 1.75%. Additionally, the U.S. central bank officially began quantitative tightening, as it moved to reduce its $9 trillion balance sheet. So far, the increase in rates has been felt most notably in the housing market. The average 30-year fixed-rate mortgage ended the quarter at 5.70% – more than double its low of 2.65% in January 2021. Higher rates have decreased homeownership affordability and raised concerns about a potential slowdown in the real estate market.
Furthermore, geopolitical tensions remained high as the war in Ukraine continued. Western governments intensified their pressure on Russia through various sanctions, such as bans on Russian oil and gold, causing the country to default on its foreign debt for the first time since 1918. Nevertheless, a great deal of uncertainty remains surrounding a potential resolution of the conflict, further complicating the outlook for global economic activity and inflation.
Performance and Attribution Summary
For the second quarter of 2022, Aristotle Atlantic’s Large Cap Growth Composite posted a total return of -22.02% gross of fees (-22.07% net of fees), underperforming the -20.92% total return of the Russell 1000 Growth Index. Since its inception on November 1, 2016, the Large Cap Growth Composite has posted an annualized return of 15.33% gross of fees (14.88% net of fees), while the Russell 1000 Growth Index has reported a total return of 15.83%.
| 1Q22 | YTD | 1 Year | 3 Years | 5 Years | Since Inception* | |
|---|---|---|---|---|---|---|
| Large Cap Growth Composite (gross) | -22.02 | -29.52 | -23.38 | 9.83 | 13.47 | 15.33 |
| Large Cap Growth Composite (net) | -22.07 | -29.65 | -23.66 | 9.40 | 13.02 | 14.88 |
| Russell 1000 Growth Index | -20.92 | -28.07 | -18.77 | 12.57 | 14.28 | 15.83 |
Sources: FactSet
Past performance is not indicative of future results. Attribution results are based on sector returns, which are gross of investment advisory fees and include the reinvestment of all income. Please see important disclosures at the end of this document.
During the second quarter, the portfolio’s underperformance relative to the Russell 1000 Growth Index was due to security selection while allocation effects contributed. Security selection in Health Care, Consumer Staples and Real Estate detracted the most from relative performance. Conversely, security selection in Communication Services, as well as an underweight in Consumer Discretionary and an overweight in Consumer Staples, contributed the most to relative returns.
Contributors and Detractors for 2Q 2022
| Relative Contributors | Relative Detractors |
|---|---|
| Vertex Pharmaceuticals | Expedia Group |
| Thermo Fisher Scientific | Nvidia |
| Dollar General | Dexcom |
| Constellation Brands | Twilio |
| O’Reilly Automotive | Snowflake |
Contributors
Vertex Pharmaceuticals
Vertex outperformed in the second quarter, outpacing the growth benchmark health care sector return. We believe Vertex benefited from investors seeking safety in the profitable large cap biotechnology stocks with attractive relative valuations. The company reported quarterly earnings in line with forecasts and gave updates on their pipeline. Vertex is starting to see a recovery in valuation, as investors appreciate the advancements in their new drug pipeline.
Thermo Fisher Scientific
Thermo Fisher contributed to relative performance, which was above the benchmark Health Care sector return. We view Thermo Fisher as a diversified leader in the life science and tools sector and a relative safe haven versus some smaller peers in the space. During the second quarter, Thermo Fisher reported earnings above forecast and raised full-year guidance.
Detractors
Expedia
Expedia detracted from performance in the second quarter following the report of disappointing first quarter earnings. Sentiment for travel-related stocks turned negative during the quarter, as recession fears increased. A recession can be expected to negatively impact demand for discretionary spending like travel-related services.
Nvidia
Nvidia detracted from performance in the second quarter, as the company saw incremental headwinds from the Russia-Ukraine war as well as the Shanghai lockdowns during the period. The company’s quarterly earnings also discussed a softening environment for gaming GPU units due to the deterioration in the crypto market. As the crypto market has continued to decline, Nvidia’s stock has weakened further as investors expect pricing and demand weakness for gaming cards. The data center business segment continues to remain strong, and the company provided a solid growth outlook for the next quarter. The increasing probability of a recession may temper the growth trajectory of the data center business in 2023, and investors began to discount this in the stock price during the quarter.
Recent Portfolio Activity
The table below shows all buys and sells completed during the quarter, followed by a brief rationale.
| Buys | Sells |
|---|---|
| Take-Two Interactive Software | Meta Platforms |
| Horizon Therapeutics | Roper Technologies |
| Tenable Holdings |
Buys
Take-Two Interactive Software
Take-Two Interactive Software develops, publishes and markets interactive entertainment solutions designed for console and handheld gaming systems, personal computers, and mobile devices. The company’s products are delivered via physical retail and digital download. Take-Two Interactive Software offers numerous video games under various developer labels, including Rockstar Games and 2K. The company’s most successful and well-known game franchises include Grand Theft Auto, NBA 2K and Red Dead Redemption.
We see Take-Two Interactive Software’s gaming pipeline as the strongest in the company’s history, with at least 19 games expected to be released over the next few years, of which less than half are believed to be sequels to existing franchises. In our view, the company’s current pipeline of game releases could drive higher revenue growth relative to past release cycles. We believe that a shift to cloud gaming over the next several years could further accelerate growth in the installed base. The mobile gaming portion of the company is a potential avenue of significant expansion for Take-Two Interactive Software, in our opinion, as the total addressable market opportunity could exceed that of the traditional gaming console market.
Horizon Therapeutics
Horizon Therapeutics operates as a biopharmaceutical company. The company develops, acquires and commercializes late-stage biopharmaceutical therapies for the treatment of pain and inflammation, as well as specialty and orphan diseases. Horizon’s main drugs are Tepezza for Thyroid Eye Disease, Krystexxa for uncontrolled gout and Uplinza for Neuromyelitis Optica Spectrum Disorder (NMOSD).
While the majority of the legacy assets in inflammation and pain will lose exclusivity over the next decade, they are expected to generate over $800 million in revenue in 2022, providing additional balance sheet capacity for future acquisitions. In addition, Horizon Therapeutics has a deep pipeline with over 20 programs with 8 data readouts expected in 2022-2023. We believe the company has a strong balance sheet, enabling increased merger and acquisitions (M&A) and business development to further compliment their on-market drug offering and pipeline.
Tenable Holdings
Tenable Holdings is a leading provider of Cyber Exposure solutions. Cyber Exposure is a discipline for managing, measuring and comparing cybersecurity risk in the digital era. Tenable is building on its deep technology expertise as a pioneer in the vulnerability assessment and management market to provide broad visibility across the modern attack surface and deep insights to help security teams, executives and boards of directors prioritize and measure Cyber Exposure. The company believes its Cyber Exposure solutions are transforming how cybersecurity risk is managed and measured and will help organizations more rapidly embrace digital transformation.
We see Tenable Holdings as being a key enabler of increased cybersecurity exposure and IT budgets. We continue to believe the cybersecurity budgets will be a core focus of C-level executives, and even when factoring in a macroeconomic slowdown, we see spending in these security areas as being relatively insulated from budget cuts.
Sells
Meta Platforms
We sold our position in Meta Platforms, as the company faces increasing ad revenue headwinds related to Apple’s privacy restrictions that make it more difficult to track consumer mobile phone activity required for ad targeting. In addition, the company plans to significantly increase capital expenditures over at least the next decade to shift its focus to the so-called Metaverse, a strategy that entails considerable risk, in our view.
Roper Technologies
We sold our position in Roper Technologies. Through acquisitions and dispositions over the past decade, Roper has transformed itself from a traditional industrial company to a company mainly focused on technology. With the change in business mix, Roper has recently been reclassified from the Industrial sector to the Information Technology sector. While the company has historically been an attractive growth company relative to the industrial sector, we are concerned that the growth rate, relative to its valuation, will be less attractive to technology investors.
Outlook
The outlook for the U.S. large cap equity market for the second half of 2022 will be impacted by the pace of the U.S. economy slowing in reaction to a Federal Reserve tightening cycle. With the focus of the Federal Reserve on raising interest rates and shrinking the balance sheet to stem inflation, there is now an increased probability of a recession. We will most likely see companies reducing earnings expectations for the balance of 2022 to reflect the uncertain economic climate. Many commodity prices like copper and lumber have already experienced sharp corrections. However, energy prices remain stubbornly high due to a sizable imbalance between supply and demand as global economies emerge from the pandemic shut down. The equity markets will most likely shift from a focus on price to earnings multiples compressing to a focus on an earnings downdraft. This could precipitate a rotation in sector performance toward defensive sectors like Health Care and Consumer Staples and away from economically sensitive sectors like Energy and Materials. Equity markets typically decline in the mid-30% range from their highs in periods of recession. The U.S. equity market is already in bear market territory having declined over 20% year-to-date. Our focus will continue to be at the company level, with an emphasis on companies experiencing secular tailwinds or strong product-driven cycles.
The opinions expressed herein are those of Aristotle Atlantic Partners, LLC (Aristotle Atlantic) and are subject to change without notice. Past performance is not a guarantee or indicator of future results. This material is not financial advice or an offer to purchase or sell any product. You should not assume that any of the securities transactions, sectors or holdings discussed in this report were or will be profitable, or that recommendations Aristotle Atlantic makes in the future will be profitable or equal the performance of the securities listed in this report. The portfolio characteristics shown relate to the Aristotle Atlantic Large Cap Growth strategy. Not every client’s account will have these characteristics. Aristotle Atlantic reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed may not represent an account’s entire portfolio and, in the aggregate, may represent only a small percentage of an account’s portfolio holdings. The performance attribution presented is of a representative account from Aristotle Atlantic’s Large Cap Growth Composite. The representative account is a discretionary client account which was chosen to most closely reflect the investment style of the strategy. The criteria used for representative account selection is based on the account’s period of time under management and its similarity of holdings in relation to the strategy. Recommendations made in the last 12 months are available upon request.
Returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Gross returns will be reduced by fees and other expenses that may be incurred in the management of the account. Net returns are presented net of actual investment advisory fees and after the deduction of all trading expenses.
The Russell 1000® Growth Index measures the performance of the large cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. This index has been selected as the benchmark and is used for comparison purposes only. The Russell 1000® Value Index measures the performance of the large cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. The S&P 500® Index is the Standard & Poor’s Composite Index of 500 stocks and is a widely recognized, unmanaged index of common stock prices. The Russell 2000® Index measures the performance of the small cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. The Dow Jones Industrial Average® is a price-weighted measure of 30 U.S. blue-chip companies. The Index covers all industries except transportation and utilities. The NASDAQ Composite Index measures all NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market. The NASDAQ Composite includes over 3,000 companies, more than most other stock market indices. The Bloomberg U.S. Aggregate Bond Index is an unmanaged index of domestic investment grade bonds, including corporate, government and mortgage-backed securities. The WTI Crude Oil Index is a major trading classification of sweet light crude oil that serves as a major benchmark price for oil consumed in the United States. The 3-Month U.S. Treasury Bill is a short-term debt obligation backed by the U.S. Treasury Department with a maturity of three months. Consumer Price Index is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. While stock selection is not governed by quantitative rules, a stock typically is added only if the company has an excellent reputation, demonstrates sustained growth and is of interest to a large number of investors. The volatility (beta) of the Composite may be greater or less than its respective benchmarks. It is not possible to invest directly in these indices.
Aristotle Atlantic Partners, LLC is an independent registered investment adviser under the Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Aristotle Atlantic, including our investment strategies, fees and objectives, can be found in our Form ADV Part 2, which is available upon request. AAP-2207-11
Composite returns for all periods ended June 30, 2022 are preliminary pending final account reconciliation.
Past performance is not indicative of future results. Performance results for periods greater than one year have been annualized. Returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Gross returns will be reduced by fees and other expenses that may be incurred in the management of the account. Net returns are presented net of actual investment advisory fees and after the deduction of all trading expenses.
