THE MARKET ENVIRONMENT
Major global markets generally showed strength during the fourth quarter, despite pressure in October when Hamas, an Islamist political and military organization, orchestrated an attack against Israel, shaking markets and the geopolitical landscape. The U.S. reported its strongest quarter of gross domestic product growth in nearly two years at 4.3% annualized, while economic data throughout Europe and China was mixed and provided reasons for both pessimism and optimism.
The U.S. 10-year yield reached as high as 5% in the quarter before declining and ending the period around 3.86% as investors continue to digest economic data and expectations on interest rates. In November and December, the U.S. Federal Reserve met and held its benchmark interest rate steady at 5.50%. Similarly, the Bank of England held its benchmark interest rate at 5.25%, and the European Central Bank held rates steady at 4.50% at its most recent meeting. Headline inflation in the U.S. and the U.K. declined during the quarter and ended at 3.1% and 3.9% in the most recent release, respectively. The Bank of Japan continued its accommodative monetary policy stance, although it took a step toward reversing the policy when it announced that the 1% cap on its 10-year government bonds would be considered a reference rate going forward. The yen reversed its recent trend and gained value during the quarter, ending the period at approximately 141 USD/JPY.
We believe our intensive research process and focus on the long term help us find opportunities despite the pervasive theme of the time. When the market does not separate the macro from the micro, there is an exploitable opportunity for long-term investors, such as ourselves. We use times of uncertainty and volatility to strategically position our portfolios for long-term success and believe this approach best positions us for achieving the protection and appreciation of our investors’ capital over the long term.
Capital One Financial, which specializes in consumer finance, was the top contributor for the quarter due to strong third-quarter results. The company’s earnings per share of $4.45 was about 37% above consensus estimates, and its loan growth, net interest margin, non-interest income, operating expenses and charge-offs were all better than consensus estimates. In regard to credit quality, management noted that while portfolio-wide monthly delinquency and charge-off rates slightly exceeded 2019 levels, those trends were stabilizing. In addition, Capital One maintains sizeable capital and liquidity buffers. Overall, we appreciate the company’s value-focused management team, consistent reinvestment in technology development and stable deposit base.
KKR was a contributor during the fourth quarter. The U.S.-headquartered financial firm’s stock price rose in December as the company negotiated terms to purchase Iris Software from Hg Capital, though later in the month Hg Capital opted to finalize a deal with its rival, Leonard Green & Partners following some disagreements with KKR. The company acquired a $7.2 billion portfolio of super-prime recreational vehicle loans from BMO Bank National Association in December and announced in late November its acquisition of the remaining 37% of Global Atlantic (GA) for $2.7 billion. Management believes this acquisition is an attractive valuation given the growth opportunity as it believes GA can double earnings over the medium term and anticipates that owning all of GA will accelerate growth, which will be beneficial to KKR’s asset management business. Lastly, KKR raised its 2026 fee-related earnings target by 12.5%, mainly due to a stronger fundamental outlook and a change in the company’s compensation framework. We continue to believe that KKR is an attractive, high-quality business and a fast-growing franchise that is run by an excellent management team.
IQVIA Holdings was a contributor during the fourth quarter. In November, the U.S.-headquartered health care company reported third-quarter earnings with strong results in the research and development solutions (R&DS) segment, which grew 11% excluding Covid-19-related work in constant currency. We believe the clinical trials industry remains healthy and IQVIA is continuing to deliver above-market growth. The technology and analytics solutions (TAS) segment delivered mainly solid results during the third quarter, in our view, despite facing a tougher macro environment on the commercial side. We view the TAS segment’s growth of 5%, excluding Covid-19-related work, in constant currency as positive as it was greater than most large-cap companies that serve in the life science industry. Lastly, management provided a preliminary look at 2024, calling for high-single-digit total revenue growth on an underlying basis. In our view, IQVIA is trading at a significant discount and remains an attractive investment.
Bayer, a life science company with pharmaceuticals, consumer health and crop science divisions, was a detractor for the quarter. During the quarter, the company announced its decision to stop its OCEANIC-AF trial for asudenxian early due to lack of efficacy. The company was ordered to pay $1.5 billion to three plaintiffs in a recent RoundUp case. While both events were disappointments, the asundexian news is more relevant to us because we expected both wins and losses in the RoundUp legal saga and anticipate this recent verdict will likely be reduced significantly on appeal. Asundexian was Bayer’s largest late-stage pharma pipeline opportunity and had potential to be a next-generation Xarelto, but the trial was riskier than usual due to its data profile in earlier stages. We have modestly reduced our estimate of Bayer’s intrinsic value, but we still believe the stock is attractively priced, trading at around 6 times 2024 earnings. We continue to monitor the situation and will adjust our analysis, if necessary. We met with new CEO Bill Anderson after the news, and we are impressed by his thoughtfulness, strong background in pharma, and urgent desire to improve the areas of the company that have held it back from its full earning potential.
Charter Communications was a detractor during the fourth quarter. In October, the U.S.-headquartered communication services company’s share price fell as its third-quarter broadband subscriptions fell short of consensus estimates. Despite the shortfall, volume remains above peers. Adjusted earnings were in-line with consensus estimates, and we believe should improve next year as there are multiple tailwinds including expense growth, mobile promotion roll-offs and a higher contribution from rural subs. In December, Charter’s presentation at the UBS conference resulted in the company’s volatility. CFO Jessica Fischer’s comments during the presentation led investors to conclude that unfavorable trends in the third quarter have continued. “In our third quarter call…we had seen a little bit of carryover churn related to the combination of Disney and rate impacts that occurred inside of Q3. November has been similarly soft, so I can certainly see that it’s likely that we could end up with negative internet net ads inside of Q4.” However, management believes this is a short-term challenge and that its total broadband opportunity in the long term has not changed. Despite the market’s reaction in the short term, we believe that Charter Communications is a solid investment.
General Motors (GM) was a detractor during the quarter as members of the United Auto Workers (UAW) union went on strike following the expiration of its labor contract in September. The strike targeted the General Motors Wentzville assembly plant, which accounts for around 7% of GM’s North American production. UAW was able to reach a deal with GM in mid-November, ending the six-week labor disruption. In December, GM’s self-driving car subsidiary, Cruise, announced it will lay off 900 employees, mainly in commercial operations and related corporate functions. These layoffs reflect GM’s decision to implement more deliberate commercialization plans, specifically emphasizing safety.
During the quarter, we purchased shares of IQVIA Holdings and Roche Holding. We eliminated General Motors and Novartis from the portfolio.
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The specific securities identified and described in this report do not represent all the securities purchased, sold, or recommended to advisory clients. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time one receives this report or that securities sold have not been repurchased. It should not be assumed that any of the securities, transactions, or holdings discussed herein were or will prove to be profitable. Holdings are representative of Harris Associates L.P.’s Global Concentrated composite as of 12/31/2023.
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