ClearBridge Large Cap Growth Strategy Q2 2024 Commentary

sankai/iStock via Getty Images By Peter Bourbeau & Margaret Vitrano Managing Through Concentration Headwinds Market Overview Equity leadership narrowed considerably in the second quarter, with mega cap growth stocks reasserting their influence and obscuring weakness across most of the market. The S&P 500 Index (SP500,SPX) rose 4.28% for the period, while the NASDAQ Composite (COMP:IND) advanced 8.26%. By comparison, the small cap Russell 2000 Index was down 3.28% for the quarter. Boosted by Nvidia (NVDA) and a handful of other semiconductor stocks riding the momentum of generative AI demand, the benchmark Russell 1000 Growth Index jumped 8.34%, outperforming the Russell 1000 Value Index by 1,050 basis points. The second quarter marked the fourth time since 2020 that quarterly style dispersion exceeded 1,000 bps in favor of growth. The Magnificent Seven contributed 8.31% of the Russell 1000 Growth’s gain, led by Nvidia and Apple (AAPL), meaning that seven mega caps were responsible for nearly 100% of index performance. This also increased the weighting of the group from 48% to 55% of the benchmark (compared to the ClearBridge Large Cap Growth Strategy’s 39% weighting). Three stocks – Microsoft (MSFT), Apple and Nvidia – now maintain greater than 10% positions in the benchmark (Exhibit 1). Exhibit 1: Market Concentration Only Worsening As of June 30, 2024. Source: FactSet.
Click to enlarge The market’s focus on AI beneficiaries further accentuated concentration risk and created near-term headwinds for diversified portfolios like ours. The Strategy underperformed the benchmark due to a combination of our mega cap allocation and stock selection. Specifically, we were hurt by underweights to Apple and Alphabet (GOOG,GOOGL), both of which outperformed the benchmark. We took advantage of recent price weakness to repurchase Alphabet in April, giving the Strategy exposure to all seven mega cap companies. Stock selection in software and consumer staples weighed on relative performance. In software, Salesforce (CRM) and Workday (WDAY) were among a cohort of enterprise software stocks impacted by weakening software spending, partially resulting from AI-related diversions of IT budgets. Within staples, weakening spending among lower-income consumers weighed on energy drink maker Monster (MNST) and mass market retailer Target (TGT) while a pressured recovery in China continued to impact cosmetics and skin care company Estee Lauder (EL). Portfolio Positioning While the Strategy continues to have a significant position in Nvidia, with the stock’s strong price appreciation during the quarter offsetting position management trims, we are underweight semiconductors versus the benchmark. That exposure worked against us in a sentiment-driven period for chipmakers tied to AI. However, we added to our semiconductor positioning during the quarter with the purchase of Taiwan Semiconductor (TSM). TSM, an out-of-benchmark name, is the world’s fabrication production provider of choice. The criticality and sophistication of the company’s manufacturing footprint powers all of the leading edge fabless global semiconductor companies, including Apple, Nvidia, Qualcomm (QCOM), AMD and Broadcom (AVGO). While AI has driven upside in data centers, PCs and handsets are at cycle lows, positioning half of the company’s business for a recovery. Exhibit 2: Semiconductors Peaking vs. Software As of June 30, 2024. Source: FactSet.
Click to enlarge A new position in Accenture (ACN) helped reduce the Strategy’s IT underweight while also providing high-quality exposure to the generative AI buildout. Accenture is a durable business well-positioned to benefit from continued growth in overall technology spending, including migration to the cloud and the ramp of enterprise AI adoption. While AI spending thus far has been largely concentrated at the infrastructure layer, we believe that service providers like Accenture will be critical to helping enterprise users implement and integrate AI into their workflows. “We have learned to not allow short-term investor sentiment undermine our long-term theses for the companies we own.” The Strategy exited a position in Intel (INTC), a semiconductor manufacturer that has not been among the AI beneficiaries in the industry. While Intel has made progress in building a U.S.-based foundry business, the timing of key product launches and profit margin improvement have been pushed out. The business also faces challenges in the current spending environment with AI architecture investments crowding out traditional CPU server spend. Other moves during the quarter included sales of United Parcel Service (UPS) and Nike (NKE). We believe our margin expansion thesis for UPS has played out, with growth now more revenue-led with macro and competitive risks increasing. This exit, along with partial profit taking in Eaton (ETN) and Grainger (GWW), consolidates our positioning in the industrials sector. Nike has become overly reliant on key platforms, like Jordan, for revenue growth while innovation in areas like running has lagged. Nike could face continued revenue and profit pressure as it invests to re-invigorate innovation and re-position the business back toward wholesale outlets. As such, we are seeking out better ways to participate in the global consumer recovery in companies where earnings estimates have already reset. Outlook AI-related momentum was a key driver of performance in the second quarter, lifting the enablers in technology as well as holdings like renewable power producer NextEra (NEE) that supply the increasing energy needs of data centers. Parts of the market lacking an AI connection, like our medical device holdings, underperformed despite no change to fundamentals. We have managed through several similar momentum periods over our tenure and have delivered long-term results for shareholders by staying true to an approach that emphasizes diversification across three buckets of growth companies (select, stable and cyclical) and seeks to take advantage of attractive entry points into quality growth businesses. We have also learned to not allow short-term investor sentiment to undermine our long-term theses for the companies we choose to own. Adobe (ADBE), for example, proved in raising guidance that the marketing and design solutions it offers are critical enough to customers to overcome perceived competition from generative AI. As growth investors, we will always have technology stocks as a core part of our portfolio, and we acknowledge that our 800 bps underweight to the sector has been a headwind in mega-cap-driven momentum periods. We have been carefully finding ways to close that gap with our recent IT purchases. Exhibit 3: Large Growth Leads Following Rate Cuts Note: Rate cut cycles of at least 75 bps. Data as of June 30, 2024. Sources: FactSet, Bloomberg, S&P, Russell, ICE BofA, NBER.
Click to enlarge Overall, we feel comfortable with our portfolio construction as the economy continues to slow. Retail sales, consumer confidence, loan growth and transport volumes are all down and the latest reading from the leading economic indicators shows signs of weakening. While higher-income consumers continue to spend, the lower end is seeing spikes in credit card delinquencies as accumulated savings from COVID have run out and the delayed impacts of Fed tightening are finally being felt. While frequency and timing remain uncertain, we see eventual rate cuts from the Fed acting as a stabilizer for the economy. We believe our portfolio companies remain well positioned to generate consistent organic growth through economic cycles. Portfolio Highlights The ClearBridge Large Cap Growth Strategy underperformed its Russell 1000 Growth Index benchmark in the second quarter. On an absolute basis, the Strategy delivered gains across five of the 10 sectors in which it was invested (out of 11 sectors total). The primary contributor to performance was the IT sector while the consumer staples and industrials sectors were the main detractors. Relative to the benchmark, overall stock selection and sector allocation detracted from performance. In particular, stock selection in the consumer staples, IT and communication services sectors, overweights to industrials, financials and health care and an underweight to IT hurt results. On the positive side, stock selection in the consumer discretionary and health care sectors and an underweight to consumer discretionary contributed to performance. On an individual stock basis, the leading absolute contributors to performance were Nvidia, Apple, Amazon.com (AMZN), Microsoft and Palo Alto Networks (PANW). The primary detractors were Estee Lauder, Salesforce, Workday, Grainger and Target. Peter Bourbeau, Managing Director, Portfolio Manager Margaret Vitrano, Managing Director, Portfolio Manager Past performance is no guarantee of future results. Copyright © 2024 ClearBridge Investments. All opinions and data included in this commentary are as of the publication date and are subject to change. The opinions and views expressed herein are of the author and may differ from other portfolio managers or the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This information should not be used as the sole basis to make any investment decision. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither ClearBridge Investments, LLC nor its information providers are responsible for any damages or losses arising from any use of this information. Performance source: Internal. Benchmark source: Russell Investments. Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and/or Russell ratings or underlying data and no party may rely on any Russell Indexes and/or Russell ratings and/or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. Performance source: Internal. Benchmark source: Standard & Poor’s.
Click to enlarge Original Post Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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