Commentary

U.S. Equity Strategy

December 31, 2020

THE MARKET ENVIRONMENT

Despite ongoing economic impacts from Covid-19, key U.S. indexes touched record high levels in the fourth quarter and both the Dow Jones Industrial Average and S&P 500 closed out the year at record levels. Reports mid-quarter about the greater than 90% efficacy of two vaccine candidates and the subsequent emergency use authorizations and inoculation rollout led to increased investor confidence that a recovery was within sight. The certification of presidential election results and the creation of a new stimulus program likely further soothed investor anxiety.

Even though a forward-looking market proved advantageous to investors, near-term conditions for the real economy, especially Main Street businesses, remained challenging. However, we took note of some positive indicators, such as accelerated manufacturing activity that reached its highest level in 17 years in October, according to the Institute for Supply Management. In addition, the National Association of Realtors disclosed that existing home sales jumped 26.6% in October from the prior year helped by near record low mortgage rates, while home prices increased due to tight inventory. Also, consumer sentiment climbed past economists’ expectations in November and early December. At the same time, retail sales fell in October and November. Nevertheless, the National Retail Federation projected holiday spending will increase between 3.6% and 5.2% compared with last year, owing to limited travel and entertainment spending along with low energy costs. While we await final holiday retail data, we are hopeful that the shift to online purchasing, which was predicted to surge up to 34% above 2019 levels, compensated for dramatically reduced in-person shopping due to Covid-19 circumstances.

A recent survey conducted by the National Association for Business Economics revealed that 73% of its 48-member panel of professional forecasters expects the economy will return to a pre-pandemic level by late 2021. This latest survey reflects greater optimism than the results from the prior survey, when just 38% of respondents said they thought a full recovery could occur before 2022. We, too, are optimistic about the future and contend that pent-up demand today for face-to-face experiences, such as travel, restaurant dining and event attendance, can lead to an outsized economic rebound after restrictions are lifted. We have worked diligently throughout 2020 to best position our portfolios to benefit from the eventual turnaround. Meanwhile, we continue to opportunistically seek out new investment candidates and rebalance portfolios when appropriate.

THE PORTFOLIO

Top Performers:
Third-quarter revenue and earnings per share from Charles Schwab were slightly better than market expectations. Although year-over-year net revenue and net profit fell, we found the results were good considering the challenging operating environment. Ongoing low interest rates continued to pressure net interest income and pushed down the net interest margin by more than 100 basis points. However, we were pleased that net new asset (NNA) growth, a metric that we see as the core business driver for the long term, remained strong. NNA finished the third quarter at $52 billion and totaled roughly $250 billion for the trailing 12-month period, which reflected a 6.5% advance from the same period last year. Third-quarter total client assets increased by 17% from a year earlier to $4.40 trillion from a combination of net inflows and rising markets. In addition, the acquisition of TD Ameritrade closed in mid-October, which management cited brings total client assets to $6 trillion and brokerage accounts to 28 million.

General Motors (GM) issued third-quarter results that were very strong, in our assessment. Total revenue of $35.5 billion met market forecasts, while adjusted earnings of $5.3 billion and adjusted earnings per share of $2.83 were impressively double the amounts the market had expected. Compared with last year, revenue was unchanged, though adjusted earnings advanced 78% and adjusted earnings per share increased 65%. All segments outperformed our estimates, mainly driven by business in North America and the GM Financial segment that was helped by credit loss provision reversals. Management’s preliminary 2021 outlook is in line with its original pre-pandemic expectations for 2020. We believe these strong results serve as a positive proof point that GM’s business model is far more resilient than expected thanks to the strength of its core truck franchise and management’s aggressive cost-cutting actions taken both pre- and post-pandemic. In addition, GM decided against taking an equity stake in electric vehicle startup Nikola after a short-seller accused Nikola’s management team of fraud. GM will continue to supply Nikola with fuel-cell technology. Overall, we see this decision as prudent.

Alphabet’s third-quarter earnings results bested consensus expectations across the board. Total revenue increased 15% in constant currency to $46.2 billion (vs. expectations of $42.9 billion) and operating income increased 22% to $11.2 billion (vs. expectations of $8.45 billion). Search revenue grew over 7% in constant currency as advertiser spend began to pick back up in August, while YouTube advertising revenue and the cloud business grew 33% and 46% in constant currency, respectively. In addition, management executed $7.9 billion in share repurchases in the third quarter to bring the year-to-date total to $23 billion. In October, the U.S. Department of Justice filed an antitrust suit against Alphabet. Later, new accusations emerged against Google from the state of Texas and a multistate coalition was filed in December. The lawsuit cites multiple violations of federal and state antitrust and consumer protection laws. In addition, the Commission Nationale Informatique & Libertés, a data protection agency in France, fined Google $121 million for installing cookies without users’ consent. The ongoing litigation and investigation activity is not surprising to us considering Alphabet’s extensive technological reach and the high-profile nature of its business. As we have stated previously, we remain pleased with the company’s fundamental performance during current challenging conditions.

Bottom Performers:
The share price of Thor Industries was weak early in the fourth quarter. However, the company reported fiscal first-quarter results that were strong, in our assessment. Total revenue advanced by 18% year-over-year and earnings per share more than doubled to $2.05. Furthermore, revenue and earnings per share surpassed market forecasts by 7% and 30%, respectively. Notably, the recreational vehicle (RV) consolidated backlog rose to an all-time high of $8.92 billion, an increase of 55% over the prior quarter and 195% from the prior year. In addition to the positive demographic dynamics for RVs that existed prior to Covid-19, the perceived safety of RV travel during the pandemic has also boosted demand. Management believes that the current backlog coupled with the historically low level of dealer inventory has created an event sequence of a robust retail sales cycle followed by a restocking cycle that will last through the end of fiscal-year 2021 and probably into 2022. CEO Bob Martin expressed to us that he is “elated” about the degree to which Thor has been able to expand its base of new customers “to millennials and younger, more diverse buyers” that should pay off well beyond the next year or two with repeat purchases. We remain pleased with Thor’s fundamental execution.

During the quarter, we initiated positions in Fiserv and KKR. We eliminated Concho Resources and Pinterest from the portfolio.

Past performance is no guarantee of future results.

The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 U.S. large-capitalization stocks representing all major industries. It is a widely recognized index of broad, U.S. equity market performance. Returns reflect the reinvestment of dividends. This index is unmanaged and investors cannot invest directly in this index.

The Dow Jones Industrial Average is a price-weighted measure of 30 U.S. blue-chip companies. The index covers all industries except transportation and utilities. This index is unmanaged and investors cannot invest directly in this index.

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 12/31/20.

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.