Commentaries

Large Cap Value

For the Period Ending: 12/31/2018

Portfolio Manager:
Matthew T. Norris, CFA

Market Update

Equity markets had a sharp fall in the fourth calendar quarter of 2018. Value investments were not immune, but the Russell 1000 Value Index, the strategy’s benchmark, fell about 2% less than the broad market. The economy and corporate earnings seem to be holding in fine, but there is fear of things worsening. Individual items such as the trade discussions with China, the lapsing of last year’s tax cut, the government shutdown and rising interest rates have soured investor enthusiasm. Looking forward, many are questioning how deep the pullback will be. Are we simply slowing back down to normal after a year in which corporate profits rose 24%, or are we headed into something more severe such as a recession? We are carefully watching job creation and interest rates as clues to answer this question.

Portfolio Review

The strategy underperformed the benchmark during the fourth quarter, primarily due to individual stock selection. Stocks in the Financials sector detracted the most. Consumer credit names had a particularly bad quarter, hurting performance. Other detractors included three key holdings that comprise a significant part of the benchmark’s Materials sector. The names adding relative performance showed less sector concentration.

Economically facing sectors fared the worst, led by Energy falling nearly 25%, and being joined by Industrials, Materials and Financials as the sectors showing the most downside. Only the Utilities sector had a positive return.

The strategy does not attempt to make sector calls, focusing primarily on stock selection. We overweight or underweight sectors based on individual stock opportunity, with some limits to control risk or volatility. The portfolio is overweight Financials and Consumer Discretionary, where we find value and yield. In these areas, we have been able to find good companies with repeatable business models generating high rates of free cash flow, and low stock prices relative to our estimation of each company’s true intrinsic value. However, these were some of the weakest areas in the fourth quarter. We are underweight Consumer Staples and Communication Services, simply due to lack of compelling ideas.

Outlook

The U.S. economy has enjoyed a long successful run from the end of the 2008 recession. There was an additional boost with the tax cut in early 2018. Once you are at the top of the mountain sometimes the only way to go is down. Recent economic data supports the idea of a slowing economy but does not support the concept of a shrinking economy (recession). The current challenge will be for the Federal Reserve to tighten money policy back up, yet not slow the economy into contraction. They have slowed their projection to indicate a likelihood of two rate hikes in 2019. Slowing the economy and inflation via rate hikes is a difficult job. We liken it to stepping on a rolling egg to stop it without breaking it. History shows a high probability of failure, if interest rates rise too much thus helping create a recession. This is something we will watch carefully.

While the economic forces listed above are clearly important factors, the portfolio management team’s first approach is from the company level. We seek to find quality, growing companies whose stocks are trading below what we consider their intrinsic value. Often this is due to short-term negative factors, and we become larger owners of a company if we feel those negatives are about to dissipate. We continue to search for and make investments one company at a time, to benefit clients over the long run.

The opinions expressed are those of the portfolio manager(s) and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through December 31, 2018 and are subject to change due to market conditions or other factors. Any mention of investment performance refers to gross-of-fees performance, unless otherwise noted.
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Investment Team

Matthew T. Norris, CFA

Senior Vice President, Portfolio Manager

Mr. Norris is portfolio manager of the firm’s Large Cap Value investment strategy and has been in this role since 2003 when he joined the firm. He was the Director of Equity Research and responsible for the firm’s equity research team from 2005 to 2010.

Mr. Norris was affiliated with Advantus Capital Management, Inc. in St. Paul, Minn. from 1997 to 2003. He joined Advantus as an equity analyst and was appointed portfolio manager in 2000. Prior to joining Advantus, he was an equity analyst and portfolio manager for Norwest Investment Management, Inc. from 1994 to 1997.

Mr. Norris earned an MBA from the University of Nebraska and a BS in Cellular Biology from the University of Kansas.

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