3rd Quarter 2011
The third quarter delivered the worst market returns (as measured by the broad market S&P 500 Index) since the first quarter of 2009, and the Fund’s worst returns since the fourth quarter of 2008. Volatility and correlations spiked as the European debt crisis was front and center, but Washington’s inability to come to a final compromise regarding the debt ceiling—leading to the downgrade of the U.S. debt rating—also didn’t help. In this type of environment it is difficult to keep one’s head above water, and stock picking goes out the window. It then becomes every man for himself and macroeconomic issues, along with market technicals, take over in a shoot first ask questions later mentality.
Correlations between stocks within the S&P 500 and the overall index itself have spiked above 80% three times since the fall of 2008. No one, especially us, would have guessed that we would experience this kind of anomaly. To make matters worse, this latest spike in correlations hit an all-time high even though the S&P 500 is up 65% from its 2009 low.
In our opinion, the macroeconomic data concerning the U.S. economy is just not that bad. It's not good, but it’s not that bad! The U.S is in far better shape today than it was in September of 2008. Back then, the economy was already contracting and the housing market was in free fall. The banking system became woefully undercapitalized once it started writing down bad loans. Major counterparty risks emerged as the system froze up and credit became unavailable. This is not the situation today, at least not in the U.S.
We feel this was an old fashioned financial panic driven by sovereign debt worries that spilled into the currency markets. If the policy makers address this problem, if only in the short run, with all of the short interest and cash on the sidelines we could see a very large rally into the end of the year much like what we witnessed in 1998.
As for the Fund, it was a miserable quarter. Anything that was tied to an economic recovery was punched in the face. As hinted above, the portfolio was not positioned for an economic slowdown.
Holdings in the Energy, Technology, and Consumer Discretionary sectors severely underperformed their Russell 1000 Growth Index benchmark sector equivalents. The index exposure to Energy is highly concentrated in big integrated oil companies such as Exxon Mobil, while we have been focused more on oil service, drillers, and exploration and production (E & P) firms. Higher volatility (beta) names such as CBS and Wynn Resorts dragged down returns within Consumer Discretionary. Finally, the Technology holdings in the Fund lost nearly 21% versus 7.7% for the index. Again, exposure was skewed towards higher-volatility networking names like F5 Networks and Riverbed Technology as opposed to the IBM’s of the world. The portfolio did hold Apple, which was positive during the quarter, and was the largest position in the Fund at quarter-end.
Positive areas for the portfolio relative to the benchmark included Consumer Staples and Industrials. Specialty beverage company Hansen’s Natural within Consumer Staples increased by double-digits during the quarter, compared with a loss overall for that segment of the index. And industrial and chemical company Goodrich was acquired by United Technologies at a healthy premium that boosted its stock.
In summary, we feel this market has discounted a fairly solid recession and a huge hit to S&P 500 Index earnings. Since 1974, U.S. equity markets have declined more than 20% seven times, five of which correctly forecasted a recession and two that did not—1987 and 1998. We just don’t buy into it this time. Yes, problems remain—housing hasn't rebounded and the lack of new jobs is disturbing. The banking system is over-capitalized now that it has written down the bulk of its bad loans, as evidenced by the huge hit to earnings in 2009. Our point is we don't think the ball has that far to fall anymore. Thus, we think if the country does slip back into recession, it should be a mild one. What if we do get some action out of the super committee, however, and Europe is successful at kicking the can down the road? On a relative basis, we think stocks are as cheap as they have been in our lifetimes and U.S. assets will attract a mountain of money from around the world. The only caveat is if the Germans decide to bail on Europe, but the credit markets are not saying that right now. This sure looks a lot like 1998.
Charles F. Mercer, Jr. CFA B. Anthony Weber Michael E. Johnson, CFA
October 12, 2011
As of September 30, 2011, Exxon Mobil comprised 0.00% of the portfolio's assets, CBS – 1.49%, Wynn Resorts – 2.89%, F5 Networks – 0.00%, Riverbed Technology – 0.00%, IBM – 0.00%, Apple – 5.09%, Hanson’s Natural – 2.54%, Goodrich – 2.52%, and United Technologies – 0.00%.
Note: Growth stocks are generally more sensitive to market moves and thus may be more volatile than other stocks.
Before investing, carefully consider the fund’s investment objectives, risks, charges and expenses. Contact 800 992-8151 for a prospectus containing this and other information. Read it carefully. Aston Funds are distributed by BNY Mellon Distributors Inc.