CWS: 2nd Quarter 2022 Portfolio Review

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Portfolio Review

During the second quarter of 2022, the financial markets faced the same challenges they faced earlier this year, although many of these challenges have only grown more severe. Most important is the continued presence of high inflation. The U.S. is experiencing the highest inflation rates in the last 40 years.

As a result of the resurgent inflation, the financial markets have also had to contend with interest-rate increases from the Federal Reserve. In June, the central bank raised rates by 0.75%. That was its largest rate increase in 28 years. During the first half of 2022, the Fed raised interest rates three times. This brought the target for the Fed funds up to a range of 1.5% to 1.75%. More rate increases are almost certainly on the way.

Inflation Hits a 40-Year High

So far these rate hikes have failed to have a significant impact on inflation, but that may soon change. According to the minutes from the Fed’s June meeting, the FOMC had been looking to raise rates by 0.5%, but the May inflation report prompted the committee to alter its plans and increase rates by 0.75%.

The Fed has conceded that more rates hikes may be need to combat inflation. So far, the Fed has made verbal commitments in its fight against inflation, but investors are still waiting to see the full force of the Fed’s efforts. Historically, inflation has been a major enemy of the stock market. During the 1970s, the stock market posted poor returns, especially once those returns were adjusted for inflation.

In addition to higher inflation and higher interest rates, the financial markets were still under pressure from the supply-chain crisis and the fallout from the war in Ukraine. The latter has had a major impact on the German economy, since it is so dependent on natural gas from Russia.

As a result of the higher interest rates from the Fed, the stock market has become much more cautious in 2022. The S&P 500 posted its worst first half to a year since 1970. Some of that is due to an unfortunate calendar, as the stock market peaked on the first trading day of the year.

During the second quarter, the S&P 500 eventually reached bear-market territory as it lost more than 20% from its high. This should not be seen as highly unusual. Historically, bear markets have occurred, on average, every four years.

While the overall market declined during the second quarter and first half of this year, that’s not how all stocks have behaved. A major divergence has opened up. Many of the popular growth stocks did very poorly during the first half of 2022. Netflix, for example, lost over 70% of its value during the first six months of this year. The stock was a popular growth stock during the period of the pandemic.

Conversely, many defensive stocks fared much better than the overall market. This can best be seen in the performance of the AdvisorShares Focused Equity ETF (CWS) during the second three months of this year. While the S&P 500 lost 16.10% during the second quarter, the traded shares of the traded AdvisorShares Focused Equity ETF lost only 12.34%. Meanwhile, the net asset value of the ETF lost 11.94%.

Though it may sound odd to highlight outperformance in a down market, this is an important characteristic in a high-quality portfolio. It’s often the case that most of the outperformance comes during difficult times. It’s easy to look smart in a raging bull market.

The Defensive Market Works to Our Favor

The shift-to-defensive effect isn’t simply felt in the stock market. We’re also seeing credit spreads widen. In plain English, that means that lenders are growing more cautious and they’re demanding a greater premium when lending to non-investment-grade borrowers. This has the effect of pushing the marginal borrower out of the credit market.

Let’s look at the some of the stocks that drove our success during the second quarter. We saw especially good results in the spring, during the first-quarter earnings season. For example, in April Fiserv (FISV) said it earned $1.40 per share for Q1. That’s a nice 20% jump from last year, and it beat Wall Street’s view by five cents. Adjusted revenue grew by 10% to $3.91 billion. Organic revenue growth was up 11%.

Fiserv stuck by its full-year forecast of $6.40 to $6.55 per share. That works out to growth of 15% to 17%.

Silgan Holdings (SLGN) said it made 78 cents per share for its Q1. That was two cents more than estimates. CEO Adam Greenlee said, “Revenues grew significantly in each of our businesses as we successfully passed through raw-material and other cost inflation to the market.”

Business is going so well that Silgan raised its full-year guidance range to $3.90 to $4.05 per share. The previous range was $3.80 to $4.00 per share. In February, the company bumped up its quarterly dividend from 14 to 16 cents per share. Don’t overlook these quiet stocks. They can be very profitable.

AFLAC (AFL) reported Q2 earnings of $1.42 per share.  That was five cents more than estimates, but the weaker yen/dollar exchange rate pinged earnings by six cents per share. Total revenues were $5.3 billion in Q1, compared with $5.9 billion last year. AFLAC’s U.S. sales increased by 19.0% to $299 million.

Commenting on the company’s results, Chairman and Chief Executive Officer Daniel P. Amos stated: “The company generated solid earnings for the first quarter, supported in part by the continuation of low benefit ratios associated with pandemic conditions and better-than-expected returns from alternative investments, despite the weakening yen. We continue to remain cautiously optimistic as we continue to navigate the pandemic. Looking at our operations in Japan, persistency remained strong in the first quarter, but sales were constrained as we continued to operate in the wake of evolving pandemic conditions, including various states of emergency that were in effect through mid-March.”

FICO (FICO) had an outstanding quarter. This is especially good news since the stock had been sliding going into this week’s report. For its fiscal Q2, the company made $4.68 per share. That beat estimates of $3.73 per share. Revenue increased to $357 million.

FICO raised its full-year EPS guidance from $14.12 to $16.08. That’s very doable. The company has already made $8.36 for the first six months of this year.

Stepan (SCL) is one of our quieter stocks, but it had another very strong quarter. For Q1, the chemical company reported earnings of $1.76 per share. The consensus on Wall Street had been for $1.32 per share. That’s a big beat.

Companywide, net sales rose by 26% to $675.3 million which means that Stepan has been able to pass price increases on to its customers.

The takeaway is that Stepan has been doing well despite dealing with lingering supply-chain issues and rising inflation. These issues are still present, but their impact appears to be fading. Stepan is on its way to another strong year.

What to Expect for the Rest of 2022?

As we enter the second half of 2022, investors should expect the stock market to remain defensive. As long as the current market threats are present, the same dynamics will be driving market behavior.

While the odds of a recession starting in the latter half of 2022 are low, for now, there is a decent chance that economic growth will slow in 2023. Historically, a flat yield curve takes some time to have an impact on equity prices. We’re already seeing hints of froth in the housing market.

Expect to see more interest-rate increases from the Federal Reserve. While the size and timing of these increases are still undecided, the Fed appears intent on winning its battle against inflation. The Fed has also talked about the important of expectations for inflation. To some extent, inflation can be a self-fulling event. If consumers expect higher prices, then they’ll get them. The Fed has frequently discussed how expectations have increased, and they want to hold back consumer expectations as best as they can.

The corporate earnings picture still looks favorable for our portfolio. For the most part, the stocks in our portfolio aren’t as exposed to the boom-and-bust cycle of the economy. Instead, our stocks tend to be companies that grow their earnings steadily no matter what the environment brings.

We should also expect to see the supply-chain issues gradually fade during the second half of 2022. This is an issue that merely needs time and proper incentives to work itself out.

Investors also face the risk of a new Covid outbreak. Many areas of the world still have regulations in place and that could hold back economic activity.

We continued to be very optimistic for the stocks in our portfolio and our overall strategy. We beat the market handsomely in Q2, and we foresee these trends lasting for the rest of 2022 and into next year.

Top Holdings

Ticker Security Description Portfolio Weight %
HSY HERSHEY CO/THE 5.60%
SAIC SCIENCE APPLICATIONS INTE 5.46%
SLGN SILGAN HOLDINGS INC 4.81%
AFL AFLAC INC 4.69%
CHD CHURCH & DWIGHT CO INC 4.57%
FICO FAIR ISAAC CORP 4.54%
HEI HEICO CORP 4.52%
REYN REYNOLDS CONSUMER PRODUCTS I 4.42%
FISV FISERV INC 4.21%
TMO THERMO FISHER SCIENTIFIC INC 4.08%

As of 06.30.2022.

Management Fee

In a first for the ETF industry, the portfolio strategist of CWS has “skin in the game.” The strategist’s compensation is directly tied to portfolio’s performance. Using the trailing 12-month returns of CWS vs. its S&P 500 Index benchmark, stronger outperformance is rewarded with a larger management fee while weaker underperformance is penalized with a smaller management fee. The CWS fulcrum fee was 0.65% during June 2022. After the Fund’s June performance, the CWS fulcrum fee will remain at 0.65% in July 2022.

 

Respectfully,

Eddy Elfenbein
Crossing Wall Street
AdvisorShares Focused Equity ETF (CWS) Portfolio Strategist

 

Past Commentary

Definitions:

The S&P 500 Index is a broad-based, unmanaged measurement of changes in stock market conditions based on the average of 500 widely held common stocks. One cannot invest directly in an index.


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