Past performance is no guarantee of future results. Investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than that shown here.
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The views expressed in this investment report represent the opinions of PNC Capital Advisors, LLC and are not intended to predict or depict performance of any investment. All information contained herein is for informational purposes and should not be construed as investment advice. It does not constitute an offer, solicitation or recommendation to purchase any security. The information herein was obtained by various sources; we do not guarantee its accuracy or completeness. Fund performance quoted above is for class I shares. Past performance does not guarantee future results. These views are as of the date of this publication and are subject to change based on subsequent developments.
Investments in value companies can continue to be undervalued for long periods of time and be more volatile than the stock market in general.
PNC Multi-Factor Large Cap Value Fund (Share Class I) returned -14.10% in the fourth quarter versus a return of -11.72% for the benchmark Russell 1000 Value Index.
In the first half of the fourth quarter, we saw a continuation of trends seen at the end of the third quarter: value factors remained weak, growth factors showed broad-based weakness with both price momentum and earnings momentum showing softness, and our proprietary quality factor, stability of earnings, continued to underperform. While value and growth factors remained weak for the full quarter, signs of strength in our quality factor emerged during the second half of the quarter as the market pullback ensued.
Stock selection detracted from relative performance in the quarter with holdings in the Financials, Information Technology, Energy, Materials, and Consumer Discretionary sectors detracting the most, partially offset by contributions from holdings in the Industrials sector.
Sector allocation overall was a contributor to relative performance with the underweight to the Energy sector and overweight to the Consumer Staples sector contributing the most, partially offset by detractions from the underweight to the Utilities and Real Estate sectors and the overweight to the Industrials sector.
S&P 500 Index earnings growth in the third quarter (reported in Q4) was 26%, continuing the trend this year of solid fundamentals for the market. Nine of the eleven Global Industry Classification Standard (GICS®) sectors reported double-digit earnings growth and five of the eleven reported more than 20% growth year over year for the third quarter period. Additionally, approximately 77% of the companies within the S&P 500 Index reported positive earnings surprises, down slightly from the second quarter earnings season. Overall, the market continued to demonstrate positive bottom-up fundamentals throughout the quarter but these strong fundamentals were not enough to offset significant macro concerns making 2018 the first year since 2001 in which the S&P 500 Index price return was negative (-6.2%) while earnings growth remained positive and strong (double-digits).
Economic indicators within the United States remain strong, however it appears that the increasingly interwoven global marketplace is having an intensifying impact on domestic stocks. Perhaps the largest concern for investors during the fourth quarter was deteriorating economic health in China, along with a weakening of their trade relationship with the United States. A fear of a global trade war dominated the market, this concern has abated somewhat in the back half but will remain a concern as we get later into the cycle.
Further Open Market Committee (the “Fed”) tightening persisted into the fourth quarter along with the yield curve flattening, causing significant discomfort among investors as this is typically considered an early indicator of recession. Uncertainty relating to global oil supply agreements put pressure on the Energy sector along with the price of oil during the fourth quarter. All of these factors, along with headwinds for other Emerging Market currencies, have led to a strengthening U.S. dollar.
While the earnings growth story has been impressive for 2018, double-digit earnings growth in each of the four earnings reporting seasons, macro factors dominated for the most of the year diverting investors’ focus away from strong fundamentals. Pressures from the threat of trade tariffs, and possibly an all-out trade war with China, concerns over Federal Reserve actions, volatile oil prices, and a flattening yield curve have been consistent themes throughout the year. Equity valuations of the S&P 500 Index constituents as measured by forward price-to-earnings ratios have started to succumb to those macro pressures ending the year with valuations below both the five-year and 10-year averages. Further, we frequently saw a disproportionate negative price impact response to earnings misses, reductions in guidance, virtually anything that could be characterized as negative news. On the other hand, earnings beats, increases in guidance, and positive news was not always met with the usual uptick in stock prices.
There is a strong correlation of earnings and stock prices overtime, in the past 10 years the correlation in the S&P 500 Index was 0.94. During 2018, there was almost zero correlation of earnings to stock prices. While these types of environments can be unsettling, history has shown us that over the long term strong earnings will prevail and drive stock prices in the United States equity markets. We will continue to focus our efforts to position our portfolio in companies with improving fundamentals that can surprise on the upside in terms of earnings. Equally important, we will continue to try to avoid those companies that may disappoint on earnings.