Commentary

U.S. Equity Strategy

December 31, 2023

THE MARKET ENVIRONMENT

U.S. equity markets 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, which, along with a resilient labor market, added fuel to the narrative that a soft landing for the economy is possible. The U.S. dollar index declined nearly 5%, marking its largest quarterly decline of the year, and WTI Crude fell over 20%.

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%. The December meeting showed a noticeable shift in rhetoric from the Federal Open Market Committee, which appears more dovish than in recent meetings. Headline inflation in the U.S. declined during the quarter and ended at 3.1% in the most recent release.

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 moments 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.

THE PORTFOLIO

Top Performers:
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.

Thor Industries was a contributor during the fourth quarter. The U.S.-headquartered consumer discretionary firm reported fiscal first-quarter earnings in line with consensus expectations and reaffirmed guidance for fiscal 2024. European results came in markedly ahead of expectations as the team is performing well operationally, in our view, and chassis supply constraints continue to abate. Additionally, management bought back $30 million of stock, in line with our expectations, and raised the dividend by 7%. Management’s fiscal 2024 outlook remains unchanged at $10.5-11 billion in revenue and 14.5-15% in gross margins. In particular, we view the margin performance as impressive considering the industry is in the midst of a downturn and management is investing in innovation through both cost of goods sold and selling, general and administrative expenses. We understand the reticence of short-term investors to buy a cyclical business during a macro downturn. However, we believe Thor Industries is an attractive opportunity for long-term investors.

Bottom Performers:
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.

APA Corporation was a detractor during the fourth quarter. The U.S.-headquartered energy company’s stock price fell in November following the release of its third-quarter results and fourth-quarter guidance. APA guided toward a modest decline in production in the North Sea during the fourth quarter due to a lack of capital spending. We continue to appreciate that at our estimate of normalized oil prices, APA generates a double-digit free cash flow yield and management is returning cash to shareholders via buybacks and dividends, which we believe can be sustained over time with maintenance capital expenditures. In our view, APA has a long runway of underappreciated inventory in the form of untapped energy assets in the group, which results in less capital they will have to spend to replace assets and grow the business over time. We believe that APA remains a solid investment.

Liberty Broadband was a detractor during the fourth quarter. The U.S.-based communication services company’s stock price fell alongside Charter Communications in October and December, due to its investment in Charter. In October, Charter released its third-quarter earnings with broadband subscriptions falling short of consensus estimates. 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.” In our view, Liberty Broadband is a very attractive holding for shareholders with a longer time horizon, despite inconveniences in the short term.

During the quarter, we eliminated Carlisle, Parker-Hannifin and Pinterest Cl A from the portfolio. There were no new purchases.

Past performance is no guarantee of future results.

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 U.S. Equity composite as of 12/31/2023.

Certain comments herein are based on current expectations and are considered “forward-looking statements”. These forward looking statements reflect assumptions and analyses made by the portfolio managers and Harris Associates L.P. based on their experience and perception of historical trends, current conditions, expected future developments, and other factors they believe are relevant. Actual future results are subject to a number of investment and other risks and may prove to be different from expectations. Readers are cautioned not to place undue reliance on the forward-looking statements.

The information, data, analyses, and opinions presented herein (including current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) are for informational purposes only and represent the investments and views of the portfolio managers and Harris Associates L.P. as of the date written and are subject to change without notice. This content is not a recommendation of or an offer to buy or sell a security and is not warranted to be correct, complete or accurate.