Market volatility has returned from an extended vacation, resulting in a roughly 10% correction for the S&P 500 since its January high and a -0.8% decline for the 1st quarter of 2018. This was the index’s first 10% correction in two years, and it broke a streak of nine consecutive quarterly gains dating back to the 3rd quarter of 2015.
For context, we should note that last year’s equity market performance was unusual for both its strength and smoothness. The S&P 500 returned 21.8% in 2017, delivering its best year since 2013 and its third-biggest yearly gain since the end of the 2008-2009 financial crisis. Meanwhile, the index experienced only eight daily price moves of at least 1% throughout the entirety of last year, the fewest since 1972. By way of comparison, in all calendar years since 1950, the index has experienced an average of 50 daily swings of at least 1% (up or down) and eleven single-day moves of at least 2%.
So far in 2018, stock investors have been subjected to a more turbulent ride. Just through the first week of April, the S&P 500 had already experienced 27 daily moves of at least 1% and eight daily moves of 2% or more. While there is some truth to the old tongue-in-cheek Wall Street adage that proclaims, “Everyone can accept unlimited (upside) volatility,” we humans tend to greatly dislike downside volatility. In fact, as first described in 1979 by Nobel Prize-winning economist Daniel Kahneman and his colleague Amos Tversky, the behavioral principle of Loss Aversion compels us to abhor losses roughly twice as much as we enjoy the equivalent amount of gains. This is probably a big part of the reason investor sentiment became noticeably more muted throughout the 1st quarter.
Our Large Cap Growth strategy performed relatively well compared to the Russell 1000 Growth Index last quarter. Most of the quarterly outperformance stemmed from positive stock selection, but our sector allocations also proved to be helpful. We did particularly well with our positions in the Health Care, Consumer Discretionary, and Technology sectors. Meanwhile, our holdings in the Materials, Consumer Staples, and Industrials sectors lagged modestly.
Our single worst portfolio contributor during the 1st quarter was Thor Industries (THO), which we had owned since the summer of 2017. Guided by our rigorous sell discipline, we liquidated our position in Thor at average prices near $120 (representing a modest gain over our average cost). Although we continue to admire the company’s product slate, industry position, and long-term prospects, we believe that earnings may be peaking for this cycle. Furthermore, we are concerned about the potential impacts of tariffs on Thor’s input costs and margins.
Late in the quarter, we also eliminated our position in Facebook (FB) at prices in the mid-$170’s. We think it is likely that the recent revelations of extensive user data misappropriation by Cambridge Analytica will not be the last unpleasant disclosure from the company. Despite the “#deleteFacebook” movement, we do not expect a material short-term exodus by users from Facebook’s platform – even if the company is forced to disclose more cases of unauthorized mining of user data. Rather, we think it is becoming increasingly likely that the company will feel compelled to alter its user agreement and interface to allow individuals to more easily “opt out” of sharing their data. Given a simple and transparent option to protect their data, we suspect many users would elect to do so. This could have the effect of reducing the price advertisers are willing to pay to access Facebook’s vast user audience, which in turn could compress the company’s margins and lower its growth rate. We will watch this situation closely, but we are sideline observers for now.
Our portfolio’s top three contributors last quarter were Netflix (NFLX), Amazon (AMZN), and Adobe (ADBE). We continue to like each of these positions. Netflix is building a global, subscription-based media content platform and is a prime beneficiary of the secular trend away from cable and satellite providers. Our current position in Amazon was established in mid-2015. Perhaps the most fanatically customer-focused company in modern history, we see a long runway of growth ahead for them in online retail and cloud computing (through Amazon Web Services). We have owned Adobe for almost two years. Their content creation software is used by marketing, production, and design professionals worldwide, and the company has successfully monetized tools that measure the effectiveness of digital advertising and market analytics.