First Quarter in U.S. Stock Funds: The Return of Volatility
Growth stocks held on to small gains as Amazon continued to rise.
The markets were jolted back to reality in the first quarter after the halcyon days of 2017.
Volatility returned with a vengeance, with the markets making some of their biggest moves in months. After going all of 2017 without a move of 2% or more in absolute terms, the S&P 500 had six such moves in the first three months of 2018, capped by a 4% decline on Feb. 5. Simmering inflation fears, the prospects of a trade war with China, and revelations of Facebook's (FB) data-harvesting activities roiled the markets during the period. As a result, the S&P 500 fell 2.1% during the quarter, its first quarterly loss since the third quarter of 2015. Small-cap stocks fared a bit better as a class during the market's swoons, though the Russell 2000 Index still lost 1.2% in the period.
Despite the market's gyrations, some 2017 story lines carried over into 2018. Growth stocks continued to outperform their value counterparts, especially as the Federal Reserve's interest-rate hike in March--its sixth since December 2015 and the first under its new chairman, Jerome Powell--made dividend-payers less attractive and put pressure on REITs. Among growth stocks, large caps led their smaller peers, paced by the extension of Amazon.com's (AMZN) stellar run. Amazon shored up the consumer cyclical sector, which joined technology as the only two sectors to advance in the first quarter.
The Primecap team's patient, contrarian growth strategy served it well in the first quarter. Primecap Odyssey Aggressive Growth (POAGX) surged 10% and led the mid-growth Morningstar Category, while sibling Primecap Odyssey Growth (POGRX) finished in the large-growth category's top decile with its 7% tally. The top holding in both funds, Nektar Therapeutics (NKTR), has quadrupled since November 2017 on positive test results for a key cancer drug and rumors of a potential sale of the company. The Nektar position shows the Primecap team's research acumen and patience: It has owned the stock in both funds since late 2009.
Fidelity Growth Company (FDGRX) captain Steve Wymer, Morningstar's 2017 Domestic-Stock Fund Manager of the Year, got off to a good start in 2018. His fund gained 4%, led by strong showings for its top two holdings, Nvidia (NVDA) and Amazon. It also benefited from renewed interest in Netflix (NFLX), which jumped 49% in the quarter. Although these are large companies, Wymer's no stranger to smaller, more obscure fare. He found BeiGene (BGNE), a Chinese biopharmaceutical firm, in early 2016 and rode the stock to new heights in 2018.
As U.S. President Donald Trump's saber-rattling on international trade shook many large caps, small-cap stocks held up rather well thanks to their reliance on the domestic economy. Artisan Small Cap (ARTSX) exemplified that strength with a 6% gain for the quarter. The fund tilted strongly toward technology, which took up nearly half of its assets in the first quarter. Its top contributor for the quarter, Veeva Systems (VEEV), took off after the market bottomed on Feb. 8, capitalizing on news of solid full-year revenue growth for fiscal-year 2018.
Rising interest rates made real estate investments less attractive in the first quarter, and some of the worst-performing funds in the Morningstar 500 (a list of funds in the Morningstar FundInvestor newsletter that meet or clear some fundamental hurdles) had significant exposure to that sector. Fidelity Real Estate Investment (FRESX), for instance, fell 7% as most stocks in its 46-name portfolio gave ground in the first three months of 2018.
One fund that didn't deliver on its expected downside protection was Royce Special Equity (RYSEX). Lead manager Charlie Dreifus' conservative approach keeps him out of high-debt companies and firms that use accounting gimmicks, and he entered 2018 with 10% in cash. But he was seriously exposed to consumer cyclicals (48% of assets in December 2017), and his top holding, The Children's Place (PLCE), gave back some of its late-2017 gains.
Mairs & Power Growth (MPGFX) isn't your typical growth fund. In fact, it's housed in the large-blend area of the Morningstar Style Box. Managers Mark Henneman and Andy Adams have a modest definition of growth--firms that are growing faster than the overall economy--but that didn't put them in the market's good graces. The fund continued its 2017 lackluster performance versus its peers as it fell over 5% in the first quarter of 2018. Its technology underweighting as of December 2017 (7.5% versus 22.0% in the S&P 500 benchmark) didn't help, and key consumer defensive picks such as General Mills (GIS) and Hormel (HRL) languished.
For all category returns through the previous day, visit the Fund Category Performance page on Morningstar.com.
Tony Thomas does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.