“The equity markets’ positive start to the year reflects a resilient consumer, moderating inflation, corporate profit resiliency, improved CEO confidence, and more favorable valuation levels following last year’s declines.”
Jennison Associates, LLC
Market in Review
The first quarter of 2023 delivered a better-than-feared outcome, led by resilient consumer spending amid continued labor market strength. Commodity prices, supply chain pressures, and freight costs all compared favorably to year-end levels.
The U.S. Federal Reserve (“Fed”) moderated its pace of monetary tightening with 0.25% rate hikes in both February and March. Over the one year since the hiking cycle began, the fed funds target rate has risen from 0.25%–0.50% to 4.75%–5.00%, reflecting the Fed’s urgency to re-establish price stability. The benchmark 10-year U.S. Treasury yield ended the quarter little changed from year end.
The collapse of Silicon Valley Bank (“SVB”), the 16th largest U.S. bank by assets, in early March marked the first significant bank failure in over a decade. Unlike the credit-induced collapse of 2008/09, SVB’s failure was triggered by abrupt and significant outflows of customer deposits sparked by the bank’s unexpected attempt to raise equity capital. A stunningly swift loss of confidence ensued, leading to a deposit run at SVB and several other large banks perceived to have similar balance-sheet risks. Regulators moved quickly to close several ailing banks and provide help through additional bank borrowing facilities and assurances around deposit guarantees. These actions bolstered liquidity and helped to restore calm.
Elsewhere, the end of China’s “Zero-COVID” policy led to a recovery of activity and easing travel restrictions to begin the year. The war in Ukraine marked a grim one-year anniversary in late February, though the mild winter mitigated the worst effects of the disruptions in energy supply across northern Europe.
Portfolio Performance
During the first quarter of 2023, the Harbor Capital Appreciation Fund (Trades, Portfolio) (Institutional Class, “Fund”) returned 18.31%, outperforming its benchmarks, the Russell 1000® Growth Index, which returned 14.37%, and the S&P 500 Index, which returned 7.50%.
Among the benchmark’s largest sectors, Information Technology, Communication Services, and Consumer Discretionary outperformed the broad index. Meanwhile, the Health Care sector declined slightly during the period.
Stock selection within the Information Technology and Consumer Discretionary sectors, along with an overweight allocation to Consumer Discretionary and an underweight allocation to Industrials, contributed the most to relative performance. An underweight allocation to Information Technology and an overweight allocation to Health Care detracted the most from relative results.
Contributors & Detractors
Nvidia (NVDA, Financial) contributed to the Fund’s performance during the quarter, rising sharply on optimism around the company’s growth opportunity as a leader in advanced computer chips that support artificial intelligence (“AI”) development.
Tesla (TSLA, Financial) also contributed to performance as its share price continued to recover, following the release of strong fourth quarter results and moderating concerns related to CEO Elon Musk’s activities outside the company. In addition, China is seeing strong recovery trends.
UnitedHealth (UNH, Financial) detracted from the Fund’s performance, as it came under pressure over concerns about 2024 Medicare reimbursement rates. A positive announcement on reimbursement rates at month’s end alleviated these concerns.
Eli Lilly (LLY, Financial) experienced profit taking during the quarter, following its strong outperformance in 2022.
Buys & Sells
We initiated a position in Advanced Micro Devices (AMD, Financial), which is benefiting from signs that semiconductors are nearing a cyclical bottom and from its growing market share in the advanced computing that supports AI.
We added L’Oréal (XPAR:OR, Financial) to the Fund, encouraged by the strength of the company’s direct-to-consumer beauty businesses worldwide. The company’s success in China is contributing to its above-industry revenue growth and rising market share.
We sold our position in KKR (KKR, Financial) over concerns about its private investment performance and debt levels in the face of rising interest rates.
We exited HubSpot (HUBS, Financial)—a smaller, not-yet-profitable company—due primarily to macroeconomic pressures.
Outlook
The better-than-anticipated start to 2023 does not alter the expectation of moderating U.S. economic activity over the balance of the year. Tighter credit conditions are a likely outcome of recent events in the banking sector. Availability of credit is likely to be constrained, as banks focus on deposit composition and resiliency, against a backdrop of rising costs and the lagging effect of liability repricing that crimps profits. Greater regulatory scrutiny should also be expected, while the status of several institutions that remain in limbo, after falling victim to deposit flight and unrealized losses on bond holdings, further clouds the outlook. The banking failures in March illustrate that the monetary tightening of the past 12 months has created heretofore unrecognized stresses in the system, and suggest a pause in further policy tightening, when combined with the lagging effects of their impact.
Companies are taking more aggressive steps on cost rationalization, expecting a more challenging environment ahead. Head count reductions feature prominently in these plans and are now impacting hiring in sectors beyond technology. Employment strains should begin to ease in the coming months and quarters as a result.
The equity markets’ positive start to the year reflects a resilient consumer, moderating inflation, corporate profit resiliency, improved CEO confidence, and more favorable valuation levels following last year’s declines. Growth companies began the year with greater valuation compression, and we believe they present a more resilient outlook in the face of a slowing economy. Corporate results from the recently concluded, fourth quarter reporting season revealed positive trends with respect to costs and inventories, and many companies have put the worst of the pandemic’s comparisons behind them. Expectations for secular growth companies now reflect renewed stability in revenue growth and profits following last year’s adjustments.
Performance data shown represents past performance and is no guarantee of future results. Past performance is net of management fees and expenses and reflects reinvested dividends and distributions. Past performance reflects the beneficial effect of any expense waivers or reimbursements, without which returns would have been lower. Investment returns and principal value will fluctuate and when redeemed may be worth more or less than their original cost. Returns for periods less than one year are not annualized. Current performance may be higher or lower and is available through the most recent month end at harborcapital.com or by calling 800-422-1050.
