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Large-Cap Report 4Q18

The stock market teetered in the fourth quarter as sentiment overshadowed economic fundamentals and drove mark indices sharply lower. During the fourth-quarter, the S&P 500® declined -13.5%, the Russell Midcap® lost -15.4%, and the MSCI EAFE® returned -12.5%. For 2018, the Indices lost -4.4% (S&P 500®), -9.1% (Russell Midcap®) and -13.8% (MSCI EAFE®). Bond returns were generally positive during the quarter as longer-dated interest rates actually declined, despite short-term rates continuing to rise. The Bloomberg Barclays Intermediate Gov./Credit Index returned 1.65% and the Bloomberg Barclays Aggregate Index advanced 1.64% during the quarter resulting in full year results of 0.88% and 0.01% respectively.

As Benjamin Graham (the father of securities analysis) said “in the short run, the stock market is a voting machine, but in the long run it is a weighing machine.” The second half of 2018 was a classic example of the “voting machine” in full effect as markets gyrated based mostly on investor sentiment. A sharp run-up (S&P 500 7.7%) in the third quarter was followed by a sharp decline (S&P 500 – 13.5%) in the fourth quarter. There was no shortage of items for investors to fret about: Fed rate hikes, U.S. – China trade tensions, the shutdown of the federal government and the continued shuffle of key White House staff. While economic data generally softened during the quarter, it continued to show growth as third quarter GDP advanced 3.2%, unemployment remained at 3.7%, wages advanced 3.1% (year over year) and third quarter earnings showed robust growth. Still, investor sentiment can have real influence over actual economic performance as confidence often drives consumer and business behavior -- which can result in a self-fulfilling situation.

Indeed, 2018 stood in contrast to last year, when the S&P 500 exhibited a “perfect” year -- when every month delivered positive returns -- culminating with a 21.8% gain for 2017. Investor psychology was giddy in 2017, not just over stocks but with speculators laying audacious bets on cryptocurrencies (think Bitcoin), VIX (the volatility measure of options on the S&P 500) and high-flying technology stocks. Much of that positive sentiment continued into 2018, reaching a crescendo in the third quarter. Since then, richly valued technology stocks have corrected, Bitcoin has fallen 80% from its peak and VIX has risen from record low levels in 2017, wiping out some investors who placed bets that low volatility would persist. Perhaps the flip-flop in 2018 wasn’t so unusual – from euphoria to fret – and may indeed create a healthier investment backdrop. In fact, if one looks at 2017 and 2018 together, the S&P 500 returned a healthy 7.9% annualized, not far off our longer-range forecast for stock returns of 6-7% per year.

Your portfolio significantly outperformed the S&P 500® Index during the fourth quarter. The portfolio’s focus on high-quality stocks was a key driver to the strong relative performance. Additionally, focus on reasonably valued stocks helped avoid exposure to the high-flying tech-related stocks (like Amazon, Facebook and Netflix) which fell sharply during the quarter. Your portfolio’s excess performance was driven by strong stock selection. In particular owning companies with strong balance sheets, stable earnings and sustainable profits that trade at reasonable valuation levels. This focus resulted in outperformance in all but two sectors. Stock selection in the Consumer Discretionary, Technology, Health Care, and Materials sectors were the most impactful along with having no exposure to the worst performing sector, Energy (-23.8% in 4Q).

The five top contributors to your portfolio’s return included: Dollar Tree (10.8%), Starbucks (13.9%), American Tower (9.5%), Omnicom (8.6%), and Copart (2.1%). The five largest detractors included: Jacobs Engineering (-23.4%), TJX Companies (-19.8%), U.S. Bancorp (-12.8%), Cognizant Technology (-17.6%), and Brookfield (-13.2%).

Graham opined “in the long run the market is a weighing machine”, meaning that economic fundamentals drive long-term value of a company (i.e. growth of sales, earnings and assets). Overall economic data have remained positive in the U.S. In fact, retail sales this holiday season were the best in six years and both auto sales and heavy truck sales remain strong. Payrolls continued to grow (averaging gains of 170,000 jobs/month in the quarter) and capital goods shipments remain steady. Additionally, with the sharp pull-back in equity prices during the fourth quarter, valuation levels have improved with the price-earnings ratio (PE ratio) showing one of its sharpest quarterly declines on record. Still, we believe that investors have merit in their concern as central banks withdrawal liquidity -- arguably one of the key drivers of asset prices -- and evidence mounts that economic growth is slowing.

Where does this leave investors as we begin 2019? We believe continued volatility should be anticipated as the market weighs economic growth, solid earnings and strong employment against tighter monetary policy, shifting interest rates, trade tensions and uncertain government policy. Without doubt, the economic expansion will come to an end but predicting that point is near impossible -- making market timing a futile endeavor in our opinion. Indeed, it was in this spirt that Graham concluded short-term markets are driven by investor psychology, but long-term markets are driven by economic fundamentals. With this in mind, we continue to believe investors are best served by choosing risk assets based upon investment time horizon and risk tolerance. This approach, along with investing in stocks of lower-risk, higher-quality companies and shorter-duration, higher-quality bonds, will allow investors to participate in the market, while providing some shelter as we experience market volatility.

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  • “Madison” and/or “Madison Investments” is the unifying tradename of Madison Investment Holdings, Inc., Madison Asset Management, LLC, and Madison Investment Advisors, LLC, which also includes the Madison Scottsdale office. Madison Funds are distributed by MFD Distributor, LLC. Madison is registered as an investment adviser with the U.S.

    Securities and Exchange Commission. MFD Distributor, LLC is registered with the U.S. Securities and Exchange Commission as a broker-dealer, and is a member firm of the Financial Industry Regulatory Authority.

    Although the information in this report has been obtained from sources that the firm believes to be reliable, we do not guarantee its accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitute the firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. 

  • S&P 500® INDEX: Widely regarded as the best single gauge of the U.S. equities market, this world-renowned index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. Although the S&P 500 focuses on the large-cap segment of the market, with over 80% coverage of U.S. equities, it is also an ideal proxy for the total market.

    Russell Midcap® Index measures the performance of the 800 smallest companies in the Russell 1000® Index, which represent approximately 35% of the total market capitalization of the Russell 1000® Index. As of the latest reconstitution, the average market capitalization was approximately $3.7 billion; the median market capitalization was approximately $2.9 billion. The largest company in the index had an approximate market capitalization of $10.3 billion.

    Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group. 

    The MSCI EAFE (Europe, Australasia & Far East) Index is a free-float adjusted market capitalization index that is designed to measure developed market equity performance, excluding the U.S. and Canada. These indices are unmanaged. They are shown for illustrative purposes only, and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is no guarantee of future results. 

    Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged index of U.S. fixed income securities. The U.S. Aggregate Index covers the USD-denominated, investment-grade, fixed-rate, taxable bond market of SEC-registered securities. The index includes bonds from the Treasury, Government-Related, Corporate, MBS (agency fixed-rate and hybrid ARM passthroughs), ABS,and CMBS sectors. 

    Bloomberg Barclays U.S. Government/Credit Bond Index includes securities in the Government and Corporate Indices. Specifically, the Government Index includes treasuries (i.e., public obligations of the U.S. Treasury that have remaining maturities of more than one year) and agencies (i.e., publicly issued debt of U.S. Government agencies, quasi-federal corporations, and corporate or foreign debt guaranteed by the U.S. Government).

    All investments contain risk and may lose value. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets.

  • “Madison” and/or “Madison Investments” is the unifying tradename of Madison Investment Holdings, Inc., Madison Asset Management, LLC, and Madison Investment Advisors, LLC, which also includes the Madison Scottsdale office.  Madison Funds are distributed by MFD Distributor, LLC.  Madison is registered as an investment adviser with the U.S. Securities and Exchange Commission.  MFD Distributor, LLC is registered with the U.S. Securities and Exchange Commission as a broker-dealer, and is a member firm of the Financial Industry Regulatory Authority. 

    Madison Investments shares all personnel and resources at their Madison, Wisconsin location. Statistical data is for the consolidated Madison organization. The Madison organization consists of its holding company, Madison Investment Holdings, Inc. and its affiliates: Madison Asset Management, LLC; Madison Investment Advisors, LLC; and Hansberger Growth Investors, LP. Asset information presented includes non-discretionary assets. Refer to each entity’s Disclosure Brochure for more information.