Q1 2023 Putnam Large Cap Value Fund Q&A
- The fund outperformed the benchmark for the first quarter and the 1-, 3-, 5-, and 10-year periods ended March 31, 2023.
- Large-cap value stocks delivered modest gains in a quarter characterized by many macroeconomic challenges.
- We are generally more cautious after the recent market advance, which was largely due to multiple expansion rather than earnings growth.
How did value stocks perform in the first quarter?
Lauren: Large-cap value stocks delivered modest gains in a quarter characterized by many macroeconomic challenges. Equity markets experienced volatility due to persistent inflation, concerns about economic growth, and continued interest-rate hikes by the Federal Reserve. The quarter also brought significant turmoil to the banking industry with the widely publicized bankruptcies of two U.S. regional banks as well as a Swiss government-engineered takeover of Credit Suisse by UBS. For the quarter, large-cap growth stocks outperformed large-cap value by a wide margin.
How did the fund perform?
Darren: The fund outperformed the benchmark for the first quarter and for the 1-, 3-, 5-, and 10-year periods ended March 31, 2023. Stock selection drove the outperformance, while sector allocation decisions had a minimal overall impact. Positions in communication services, health care, and consumer discretionary were top contributors to performance. Stock selection in the industrials, financials, and real estate sectors detracted from returns. The benefit of our underweight position in the challenged financials sector was offset by an underweight position in the top-performing communication services sector.
Financials make up a significant portion of the value universe. What are your thoughts on the regional bank crisis?
Darren: It’s important to note that this was not a systemic problem like that of the global financial crisis in 2008. It was not a solvency issue, but rather a liquidity issue, which the Fed has both the tools and the experience to manage. The Fed moved quickly and effectively, with a focus on regional banks most at risk — those with less diversified business models. The second-order effects of the crisis may be more challenging for investors. Deposits have flowed out of smaller banks and into the larger institutions. This has had the effect of drying up credit availability and tightening financial conditions beyond what the Fed is already doing in terms of raising interest rates. As financial conditions get tougher, the chances of a recession increase.
Lauren: In terms of our portfolio, we believe our positioning, which favored large banks over regional banks, was beneficial in navigating the challenges. Also, within regional banks, we owned PNC, which held up better than many other regional banks. It is known as a “super regional” bank, is the fifth-largest bank in the country, and is well diversified. No single industry represents more than 15% of its loan book.
Going forward, PNC and the largest banks should benefit from consumers’ flight to quality. Also, the size and scale of these banks should enable them to handle any increased regulation or compliance requirements in the wake of the crisis. At the same time, smaller banks may have a harder time keeping up with any new regulation or capital requirements.
What is your outlook for the months ahead?
Darren: We expect continued volatility and modest returns for equity markets. Labor markets remain tight, which will make inflation an ongoing threat, especially for services, a key component of the Consumer Price Index. While we do foresee an end to interest-rate hikes in 2023, we do not expect cuts any time soon. We believe the Fed is likely to hold rates at the peak level for longer than many investors expect.
Lauren: Along with the ongoing tightening of financial conditions, particularly among regional banks, we are generally more cautious after the recent market advance, which was largely due to multiple expansion rather than earnings growth. The market appears to be setting itself up for a negative surprise as first-quarter earnings are expected to show an overall decline.
As always, we don’t try to predict the magnitude or duration of macroeconomic forces. Instead, we focus on how they might impact the profitability of the companies we own. And we seek to manage the fund’s sensitivity to these challenges through careful portfolio construction and stress testing.
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