KEY TAKEAWAYS
- The Fund (Investor Shares) returned 10.17% for the quarter, outperforming the Russell 1000 Value Index's 8.99%.
- The outperformance was largely driven by stock selection in the Information Technology and Communication Services sectors. Our overweight in Financials and underweight in Real Estate also contributed.
- We have positioned the Fund for an environment in which inflation continues to moderate, economic growth stabilizes, unemployment remains low, and credit conditions gradually loosen.
- This confluence of factors should broaden stock market gains to more sectors, an expectation that drives our overweight allocations in Financials, Communications Services and Health Care.
Market Review
U.S. equities surged in the first quarter of 2024 as the economy continued to perform above expectations. Large-cap value stocks underperformed the broader market but still advanced strongly, as the Russell 1000 Value Index gained nearly 9% versus more than 10% for the S&P 500. Analysts tempered their projections for the timing and number of interest rate cuts by the Federal Reserve this year as inflation estimates trended higher. Greater confidence in U.S. economic growth drove more demand for borrowing and improved the environment for lending, benefiting banks. Within the Russell 1000 Value Index, the rally broadened relative to 2023 as the Energy, Financials and Industrials sectors led their peers and only Real Estate posted a negative return. The artificial intelligence (AI) - related momentum and optimism that characterized much of 2023's market activity continued in the quarter, especially within the Semiconductor industry.
Performance Review
Outperformance driven by Information Technology
The Fund returned 10.17%, better than the Russell 1000 Value's 8.99%. From the sector perspective, stock selection in Information Technology contributed the most to relative performance, followed by selection in Communication Services and Real Estate. Our overweight in Financials and underweight in Real Estate also contributed. Stock selection in Health Care, on the other hand, hindered relative results. The Fund's lack of exposure to Energy, the best-performing sector in the benchmark for the quarter due to a spike in oil prices, also detracted.
Top Contributors
Micron (MU, Financial) shares soared as price increases in memory and storage end markets improved profitability. The semiconductor company remains well-positioned to capitalize on the surging demand for AI infrastructure.
Progressive (PGR, Financial) shares appreciated as investors reacted well to the insurer's latest financials, including higher-than-expected-growth in net premiums. The company's consistently profitable underwriting, scale advantages and strong execution are becoming more evident to investors as it continues to gain market shares.
Fidelity National Information Services (FIS, Financial), a global financial technology company, issued an optimistic outlook for the remainder of 2024, buoying its stock. Improved cost management and completion of the Wordplay spin-off were additional positives.
Cummins (CMI, Financial), a leader in diesel and alternative fuel engines and generators, guided to a shallower-than-expected downcycle in 2024. New rules from the Environmental Protection Agency are expected to drive higher demand for the company's truck engines in the coming years.
Western Digital (WDC, Financial) results surpassed expectations across the board, in earnings, revenues and outlook. The company is favorably positioned to capitalize on long-term growth opportunities in data storage.
Bottom Contributors
Intel (INTC, Financial), one of the world's largest semiconductor chipmakers, reported strong results for the fourth quarter, but its sales outlook for the first quarter fell short of expectations. While demand for the company's central processing units may be temporarily weak, we believe the market for Intel's personal computer and data center chips will continue to grow.
Biogen (BIIB, Financial) lagged as the launch of its Alzheimer's drug is proving slower than expected. Management has taken steps to improve the global biotechnology company's financial position, including cost-cutting measures.
Gilead Sciences (GILD, Financial), a global biopharmaceutical company, saw its shares decline as a cancer drug failed to expand into additional lung indications, denting investor faith in the company's oncology franchise. We maintain confidence in Gilead's core HIV franchise and ability to expand into cancer treatment portfolios.
Brookfield Renewable (BEPC, Financial) shares were impacted by below-average generation within the renewable energy investment company's hydroelectric portfolio. Despite this short-term variation, the company remains well-placed to benefit from the growing demand for renewable power.
S&P Global (SPGI, Financial), a leading financial information and data analytics services company, ended the quarter down after reporting mixed results, with revenue growth topping expectations but earnings and 2024 guidance falling short due to macro uncertainty around debt issuance volumes.
Portfolio Positioning
Positioned for market gains to broaden
The Fund's most significant overweights relative to the benchmark as of March 31, 2024, were in Information Technology, Communication Services and Financials, while its three largest underweights were in Energy (a zero allocation for the Fund), Industrials and Consumer Staples.
We currently maintain a balanced positioning between offensive and defensive sectors, with a slight tilt to offense as we seek to capitalize on growing market breadth. Positions in payment processing companies and within the Semiconductors, Software and Capital Markets industries should do well if the market continues to rally and economic uncertainty resolves in a soft landing (modest growth with inflation trending lower) or no-landing (higher growth than anticipated with inflation above 2%) scenario. Positions in Communication Services, Health Care, Industrials and Utilities should fare well if a recession arises.
During the quarter, we added new positions in Pfizer (PFE, Financial), NICE (NICE, Financial) and Charter Communications (CHTR, Financial). We purchased Pfizer to capture the potential upside from any turnaround following the COVID-induced boom-bust cycle of the last few years. NICE is a leading cloud contact center software company. We believe its customers will increasingly adopt AI-enabled customer experience software, driving double-digit revenue growth. Charter's stock had fallen due to near-term concerns, which we believe will not have a major impact on the long-term value of the business.
We also closed out two positions, BioMarin Pharmaceutical (BMRN, Financial) and Amdocs (DOX, Financial), to invest in other opportunities with more potential upside.
Outlook
Finding bargain opportunities in a concentrated market
The first quarter of 2024 carried forward several macroeconomic trends witnessed in 2023. Gradual improvement in inflation and strong wage growth continued to offset the negative impacts of declining excess savings and tighter credit conditions.
Stocks have had a solid start to the year and the Fed's outlook for lowering rates in the coming quarters bodes well for further gains. While a handful of companies drove the majority of market returns in 2023, we believe strong consumer spending underpinned by low unemployment should support earnings growth for a broader set of companies in 2024. In the shadow of last year's concentrated returns, bargain opportunities began to emerge in other parts of the market overlooked by investors. Our time-tested bottom-up stock selection process, which emphasizes price discipline, business quality and sustainability characteristics, is designed to identify such bargains.
Moreover, risk management is integral to our investment process. We carefully assess scenarios that could result in permanent loss of capital and avoid placing undue reliance on optimistic long-term forecasts. Our track record since 2005 reflects this commitment to assessing both return and risk.
Before investing, an investor should carefully consider the investment objectives, risks, charges and expenses of a fund and should carefully read the prospectus or summary prospectus, which contain this and other information. The prospectus or summary prospectus can be found on the website, www.parnassus.com, or by calling (800) 999-3505.
