“Uncertainty about the U.S. economy's ability to avoid recession remains a focus entering 2024. We believe the evidence suggests slowing growth but not outright recession ahead.”
Jennison Associates, LLC
Market in Review
In early December, the U.S. Federal Reserve's (“Fed”) decision to leave the federal funds rate unchanged included the surprising statement that the pace of inflation had cooled sufficiently, and that the Fed did not anticipate any more rate increases. Markets rallied following the announcement.
During the fourth quarter of 2023, the U.S. economy showed incremental softness in hiring despite the resilience of the labor market; oil prices trended lower; and the average U.S. home price remained at historically high levels, despite a dearth of activity in both existing home sales and new construction throughout 2023.
Economic growth outside the U.S. remained muted. In China, the latest residential real estate setback continued to sap the strength of its post-COVID-19 recovery. Ongoing tensions over access to U.S. and international technology led to new restrictions on the purchase of advanced machinery — notably leading-edge semiconductor manufacturing technology — by Chinese enterprises and government agencies. In Europe, growth remained slightly positive to close the year.
Currently, the Harbor Capital Appreciation Fund (Trades, Portfolio)'s (“Fund”) positioning reflects many of the same investment themes as seen over the past 12 months. We continue to own a diversified Fund of companies that we believe will grow faster than the market averages in revenue, cash flow, and earnings, as well as outpace the growth of a broad universe of growth stocks as represented by the Russell 1000® Growth Index.
Portfolio Performance
During the fourth quarter of 2023, the Harbor Capital Appreciation Fund (Trades, Portfolio) (Institutional Class) returned 16.30%, outperforming its benchmarks, the Russell 1000® Growth Index, which returned 14.16%, and the S&P 500 Index, which returned 11.69%.
Stock selection within the Information Technology, Industrials, and Consumer Staples sectors added the most value. Stock selection within the Health Care sector, along with an underweight in Information Technology, detracted the most from relative performance.
Contributors & Detractors
Microsoft (MSFT, Financial) contributed to the Fund's performance, with the stock price rising on the potential artificial intelligence (“AI”) tailwinds ahead, the stabilization of its personal computer market, and its Azure (cloud computing platform) market share gains. The company continues to innovate and invest for future profitability.
Amazon's (AMZN, Financial) Amazon Web Services (“AWS”) subsidiary was a strong contributor to Amazon's share performance. Amazon is poised for reacceleration; its e-commerce performance remains robust; and free cash flow is improving.
Argenx (ARGX, Financial) shares detracted from Fund performance, declining on the release of disappointing clinical outcomes for one of the products it has in development.
Tesla (TSLA, Financial) also detracted from performance. Its shares were down slightly during the quarter — without a major catalyst. However, the stock outperformed for the full year.
Buys & Sells
We initiated a position in Boeing (BA). After being a laggard since the pandemic, the company is now reaching an inflection point. Production is ramping up on its key 737 and 787 platforms, which should drive free cash flow meaningfully higher. Note: We are watching the circumstances surrounding the grounding of the 737 Max 9 in early 2024 very closely. However, we believe that Boeing offers unique growth potential that is largely independent of the macro environment, given its backlog.
We sold our position in Argenx because the company experienced two setbacks in drug development trials, which called into question our longer-term thesis about the company's pipeline of autoimmune products beyond Vyvgart. We decided to liquidate the holding, which was a small position in the Fund, given the resulting uncertainty and valuation implications .
Sector Overweights & Underweights
Sector weights are a by-product of our research-based stock selection. At the beginning of the year, the Fund's largest sector overweights/underweights relative to the Russell 1000® Growth Index were in Consumer Discretionary (overweight) and Information Technology (underweight). As of December 31, 2023, the largest sector overweight relative to the index was in Consumer Discretionary. The biggest underweights relative to the benchmark were in Industrials and Information Technology.
Outlook
The grudging pace of the U.S. economic slowdown might be the biggest surprise of the year. Consumer resiliency in the face of geopolitical and macroeconomic turbulence is the primary reason, reflecting low unemployment, balance sheet strength, and rising financial asset prices. Uncertainty about the U.S. economy's ability to avoid recession remains a focus entering 2024. We believe the evidence suggests slowing growth but not outright recession ahead. The easing pace of inflation, along with lower borrowing costs, are new tailwinds to activity. Wage rates, one of the last contrary indicators, are no longer rising and, in some cases, entry-level pay is now below the pandemic peak. Finally, corporate profits broadly have favorably weathered the post-pandemic period, despite the demand pull-forward and supply chain disruptions.
Taken together, the past two-plus years encompassed financial market distress driven by historic inflationary pressures and interest rate increases, followed by a rebound in asset prices to levels that, in some cases, reached near peaks. Valuation has played a significant role in both the decline and rebound of asset prices. This period has been challenging, but we note that the Fund holdings have participated meaningfully in the economic recovery. These companies have navigated throughout a difficult environment in strong financial and operational health.
Secular growth opportunities should drive earnings and revenue increases for the Fund holdings ahead of benchmark averages over our investment time horizon. However, much of this potential is now reflected in share prices. Thus, the Fund's long-term growth potential remains favorable, but near-term share price gains should be more measured.
Disclosures
All holdings-related data is provided by FactSet. Because FactSet relies on external sources for its data, that data may differ slightly from actual values maintained by Harbor Funds.
Due to the security valuation procedures of the Fund and intra-day trading activity not included in the FactSet calculations, the actual returns may vary. From time to time the cash return in the portfolio may appear distorted based on the way FactSet's attribution calculation methodology addresses delayed settlements.
Beta is a rolling three year, unless the Fund has a track record of less than three years, in which case it is a rolling one year.
Best and Worst Performers sections reflect stocks in the portfolio for the quarter with an average weight of 0.25% or greater.
Views expressed herein are drawn from commentary provided to Harbor by the subadvisor and may not be reflective of their current opinions or future actions, are subject to change without prior notice, and should not be considered investment advice.
This information should not be considered as a recommendation to purchase or sell a particular security. The weightings, holdings, industries, sectors, countries, and returns mentioned may change at any time and may not represent current or future investments.
As a result of changing market conditions, total net asset levels, expenses and other statistics may change at any time and may differ from those shown.
The total amount shown for sector, industries, or country holdings may be greater than 100% because of the inclusion of derivatives and the collateral securities supporting those instruments.
Sector allocations are determined using the Global Industry Classification Standard (GICS), which is a service of Morgan Stanley Capital International (MSCI) and Standard & Poor's (S&P).
Investors should carefully consider the investment objectives, risks, charges and expenses of a fund before investing. To obtain a summary prospectus or prospectus for this and other information, visit harborcapital.com or call 800-422-1050. Read it carefully before investing.
Jennison Associates LLC is an independent subadvisor to the Harbor Capital Appreciation Fund (Trades, Portfolio) and CIT.
Distributed by Harbor Funds Distributors, Inc.
