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November 8, 2017

PMV October 2017 Month In Review

Macro

October’s historical volatility a distant memory

Economic data remains largely positive with a solid October jobs report driving unemployment to a 17-year low at 4.1% and third quarter GDP estimates exceeding expectations at 3.0%.  The U.S. equity markets continued their unabated march higher in October with virtually all major U.S. indices advancing, including the Russell 3000 Index up over 2%.  Within market cap and style boxes, last month was more of the same, with large caps outpacing small caps and growth widening its lead over value.

While October has historically been the most volatile month of the year, last month was anything but, continuing an anemic pattern.  Historically, low volatility has been a root cause for many of the trends we have seen in this market (e.g.. passive flows, growth vs. value, momentum).  The Chicago Board Options Exchange Volatility Index (VIX) does not even tell the whole story, as the data shown below through October 30, 2017 from Credit Suisse note suggests.  We are truly living in historic times, and while we do not know when certain factors will normalize (valuations, volatility), we stand ready to take advantage and protect capital when they do.

Earnings

Start to Q3 earnings generally solid

While the Mid Cap PMV portfolio was relatively flat vs. the Russell Mid Cap Value Index in October, we were encouraged to see EPS season off to a stronger note vs. Q2.  Of note, Northern Trust, Citizen’s Financial, BorgWarner, and Snap-On all beat expectations.  In addition, despite posting generally weak Q3 results, Axalta shares rose last month on news of a potential merger with Akzo Nobel.  Unfortunately, encouraging earnings were offset by a few factors, including: weak performance in Health Care (e.g., Universal Health Services) due to uncertainty about ACA and lack of PMV participation as higher beta stocks within Tech and Industrials rallied.

Portfolio

Finding pockets of opportunity in otherwise frothy market

In our view portfolio transactions remain largely muted in a frothy market.  However, we did purchase a new position in J.M. Smucker (SJM) last month.  The stock was at a 52-week low amid a tough landscape for consumer staples, especially branded food companies where increased competition from private label and changing consumer habits are pressuring profits.  However, we believe that Smucker is well-positioned given their mix of leading brands (75% are #1 or #2) within still-growing categories like pet food, coffee, and healthy snacks.  Pet food and coffee together now represent 2/3 of total company EBITDA.  We also believe that margins will stabilize in the coming periods due to lower coffee costs and better coverage of marketing spend with the ramp of several new product launches.

In other portfolio news, we trimmed Aramark (ARMK) following the announcement of two large acquisitions with a combined sticker price of $2.3 billion.  Even though we believe these deals make strategic sense (one in uniform rentals and the other in food & hospitality procurement), the multiple paid north of 12x EBITDA seems a bit aggressive to us based on our PMV work.  So, with the stock up on the news, we took some profits and are analyzing these deals for future impact.


The securities identified and described do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable. All expressions of opinions are subject to change without notice in reaction to shifting market conditions.  All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness.  Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. 

Russell 3000 Index: an unmanaged equity index which measures the performance of the 3,000 largest U.S. companies based on total market capitalization.  An investment cannot be made directly to an index.

Russell Midcap Value Index: an unmanaged equity index that measures the performance of those Russell Midcap companies with lower price-to-book ratios and lower forecasted growth values.  An investment cannot be made directly to an index.

Chicago Board Options Exchange Volatility Index (VIX): an unmanaged index calculated from options on the S&P 500 Index and is supposed to reflect the market expectation of the index’s annualized 30-day volatility. The volatility measured by the VIX reflects both the possibility of upside movements as well as the possibility of downside movements.  An investment cannot be made directly to an index.