Market Commentary
The S&P 500 Index finished the year up 11.95% after the worst ever first two weeks of the year. The Dow Jones Industrial Average followed suit returning 16.50% for the year with the Nasdaq Composite lagging behind both, closing out the year with a rise of 8.97%. Ten out of the eleven sectors in the S&P 500 posted positive returns at year end, with Energy and Telecommunications gaining the most with returns of 27.36% and 23.49%, respectively. On the other hand, Healthcare did the worst posting returns of -2.69%. Small-caps outperformed mid-caps, which beat large-cap names. Specifically, the small-cap Russell 2000 Index returned 21.28%, ahead of the Russell MidCap Index’s 13.78% return for the year. The large-cap Russell 1000 Index posted 12.04% returns. Value stocks outperformed growth stocks with the Russell 1000 Value rising 17.33% compared with the Russell 1000 Growth Index’s increase of 7.07% over the year. Stocks outperformed bonds, with the Barclays U.S. Aggregate underperforming all equity benchmarks with a 2.65% return. Long dated US Treasuries underperformed with the Barclays Long-Term Treasury Index rising 1.43%. Gold rebounded in 2016, increasing by 8.05%. The US Dollar Index continued its appreciation, increasing 3.63%, while oil prices bounced back from 2015 rising 45.03%. All major developed countries ended the year up in local currency terms, with Canada being the top country with a total return of 21.08% in local currency terms. Emerging market countries also had a strong year with Brazil and Russia posting the large gains in local currency terms, 38.93% and 32.77%, respectively.
The stock market continued to move higher in the fourth quarter following the election results in November. The Dow Jones Industrial Average led the charge with an 8.66% quarterly gain while the S&P 500 gained 3.82% and the Nasdaq Composite rose 1.69%. The market started the quarter down with apprehension before the election but rebounded afterwards with the move higher being coined the “Trump Rally”. In December, the Fed raised interest rates for the second time in almost a decade. Eight out of the eleven sectors in the S&P 500 posted positive returns for the quarter, with Financials and Energy gaining the most with 21.05% and 7.28% returns, respectively. Real Estate and Health Care performed the worst with losses of -4.41% and -4.00%, respectively.
Strategy Highlights
During the fourth quarter of 2016, Opportunity Equity returned of 1.74% (net of fees).1 In comparison, the Strategy’s unmanaged benchmark, the S&P 500 Index returned 3.82% for the same period.
Using a three-factor performance attribution model, sector allocation contributed to the strategy’s performance, which was offset by security selection and interaction effect. JPMorgan Chase & Co. Warrants (JPM/WS), United Continental Holdings (UAL), Bank of America Corp. (BAC), Delta Air Lines Inc. (DAL) and American Airlines Group Inc. (AAL) were the largest contributors to performance, while Valeant Pharmaceuticals International Inc. (VRX), OneMain Holdings Inc. (OMF), Amazon.com Inc. C300 1/17, Genworth Financial Inc. (GNW) and Quotient Technology Inc. (QUOT) were the largest detractors.
Relative to the index, Opportunity Equity was overweight the consumer discretionary, financials, industrials, healthcare, and materials sectors on average during the quarter. With zero allocation to utilities, Consumer Staples, Energy, Real Estate and Telecommunications, the Strategy was dramatically underweight these groups. In terms of sector allocation, the overweight position in the financials sector, which outperformed the index, contributed the most to the Strategy’s relative performance. On the other hand, the underweight in the energy sector, which outperformed the index, detracted the most from relative performance.
We initiated six positions during the quarter and eliminated seven, ending the quarter with 36 holdings where the top 10 represented 47.03% of total assets, compared with 18.16% for the index, highlighting Opportunity Equity's meaningful active share of around 105.86%2.
Top Contributors
- Both the JPMorgan Chase & Co. Warrants and Bank of America jumped in the fourth quarter after the election climbing 77.83% and 41.12%, respectively. Both companies reported third quarter EPS beats with JPMorgan beating estimates by $0.19 and Bank of America beating by $0.07. The beats were attributable to better than expected FICC trading, IB fees, and lower loan loss provisions. The stocks continued to move even higher after the election on expectations of lower tax rates, less regulations, and higher interest rates.
- United Continental Holdings continued its move higher ending the period up 37.98%. The stock was pushed higher on the announcement that Warren Buffett initiated stakes in four airlines, including UAL. United released its November traffic showing consolidated traffic up 1.7% YoY and announced improved guidance for fourth-quarter PRASM of -3% to -4%. At their investor day in November, management added credibility to their focus on closing the margin gap between United and other legacy carriers.
Top Detractors
- Valeant Pharmaceuticals International Inc. declined 40.45% over the quarter. Third quarter results missed consensus estimates with EPS of $1.55 versus expectations of $1.75. The company lowered full year 2016 revenue guidance of $9.55-$9.65B from $9.9-$10.1B. EPS guidance was also lowered to $5.30-$5.50 from $6.60-$7.00. The company was further pressured by its decision not to proceed with the sale of Salix, the continuing investigations by the SEC and Justice Department and Pershing Square Capital (Director) announcing the sale of $51.6M in stock in order to “generate a tax loss in 2016 for their investors”. During the period, the company also announced the departures of former CFO Rob Rosiello, EVP and Company Group Chairman, Dr. Ari Kellen and EVP and Group Chairman, Ann Whitaker while appointing William D. Humphries as EVP, Dermatology. In early 2017, the company announced $2.1B in asset sales which will be used to pay down debt.
- OneMain Holdings Inc. ended the quarter down 27.55% as a result of disappointing third quarter performance and lower full year and 2017 guidance. The company announced 3Q EPS of $0.19, drastically below consensus of $0.45 as a result of weaker NIM as originations were lower than expected. OMF lowered full year 2016 EPS guidance by 18% and lowered 2017 EPS guidance to $3.75-$4.00 from $5.60-$6.10. The company attributes the lower guidance to integration problems with the legacy business which is resulting in slower growth. In the New Year, OMF received an unsolicited exchange offer from IEG Holdings Inc. which was unanimously rejected by the Board of Directors which stated that the offer was “grossly inadequate and reckless”.
- The Amazon.com Inc. C300 1/17 call options declined 17.71% during the quarter following inline third quarter results but disappointing fourth quarter operating income guidance of $0-$1,250M versus consensus of $1,700M. The company noted increased investments in fulfillment centers, increased prime services and investments in India. During the period, Amazon had a positive showing at the 2016 CES with Alexa integrated in multiple third party products. AWS continues to outpace its peers as it is releasing new capabilities at a rapid pace with Amazon expecting 1,000 total new releases in 2016.
Read Bill Miller's 2017 Outlook
1For important additional information on Opportunity Equity strategy performance, please click on the Opportunity Equity GIPS Composite Disclosure. This additional information applies to such performance for all time periods. Past performance is no guarantee of future results.
2Active share represents the share of strategy holdings that differs from the benchmark index holdings. The greater the difference between the asset composition of the strategy and its benchmark, the greater the active share.
Contact LMM to obtain information on how Top Contributors and Top Detractors were determined and/or to obtain a list showing every holding’s contribution to Strategy performance.
Investment Risks: All investments are subject to risk, including possible loss of principal.
The views expressed in this report reflect those of the LMM LLC (LMM) as of the date of the report. Any views are subject to change at any time based on market or other conditions, and LMM disclaims any responsibility to update such views. The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned. Past performance is no guarantee of future results.
©2017 LMM LLC. LMM LLC is owned by Bill Miller and Legg Mason, Inc.
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