TCW Funds Q2 2024 Commentary: Navigating Market Challenges and Opportunities

TCW Relative Value Large Cap Fund Q2 2024 Commentary

Global economic outlooks vary, with the U.S. leading in growth, while the U.K. and Eurozone face stagnation, and China implements stimulus measures. The U.S. economy remains resilient and a standout among developed economies. The final read for 4Q:23 Gross Domestic Product (GDP) showed the economy grew 3.4%, better than Street* expectations. Growth was led by strong consumer and government spending. The GDP report might have been stronger if not for the labor strikes during the quarter. With some of the weakness stemming from seasonal adjustments and harsh weather, January retail sales were down -1.1% m/m, but they rebounded to 0.6% m/m in February. Recent comments from retail CEOs (Coca-Cola,† Hershey,† Walgreens†) highlight the "cumulative impact of inflation" and customers "seeking value." Yet, the wealth effect from a roaring stock market has buoyed up discretionary spending. S&P 500 (SP500,SPX) EPS for 4Q:23 was 10.1% with revenue growth of 3.7% per LSEG I/B/E/S. Inflation in the U.S., while far off its highs, is not yet at the Federal Reserve's (Fed) 2% target. The February CPI and PPI data were a touch hotter than expected but traders brushed off the reports as they still anticipate the Fed to cut. The Fed's preferred gauge, Core PCE, for January and February came in line with expectations at 2.8% y/y. The January and February inflation numbers may be due to one-time annual repricing such as health insurance contracts that may not be accurately adjusted for seasonally. Higher than anticipated prices for used cars, air travel, and clothes buoyed up the CPI while for the PPI it was higher fuel and food costs. The U.S. Fed made no move in March while the Bank of Japan (BOJ) tightened a touch. Unexpectedly, the Swiss National Bank ('SNB') jumped ahead of the line to cut rates making it the first developed market central bank to do so since the pandemic. The Fed announced that the one-year Bank Term Funding Program (BTFP) will not be extended and was closed to new loans on March 11. This program was created last spring in the wake of the regional banking crisis to ensure that banks could meet their liquidity needs. Post the BTFP closure, banks are encouraged to use the Fed's primary discount window should they need to borrow. Liquidity was not New York Community Bank's† need prior to its tumultuous entry into Category IV. Regulatory requirements resulted in a dividend cut and asset write downs in commercial real estate, specifically multi- family homes. To prop up China's real estate market, the People's Bank of China ('PBOC') announced its largest-ever cut in the benchmark mortgage rate, lowering it by 25 bps to 3.95% following January's cut in its Required Rate of Reserves ('RRR'). These actions should help stimulate China's economy. Concerns persist after 11 Chinese companies lost their credit ratings at Moody's Investors Service which withdrew the scores in an unusual flurry that underscores fallout from record defaults. Finally, the U.S. Senate passed the so-called mini-bus appropriations bill that completes the funding process for fiscal year 2024. Any threat of government shutdown has been averted. Over the course of the first quarter, the best performing sectors in the Russell 1000 Value were energy (+13.8%), financials (+13.2%), and industrials (+11.8%). Real estate (-0.9%) was the worst performer and the only in negative territory and was followed by the traditionally defensive utilities (+5.2%), health care (+6.3%), and consumer staples (+6.7%). The strategy's sector allocation detracted with the benefit from the underweights in utilities and consumer staples offset by the underweights in energy and industrials and overweights in health care and information technology. The portfolio's top ten average-weighted (over the course of the quarter) names returned 16.1%, on average, better than the overall portfolio and benchmark index with seven generating double-digit gains led by General Electric (GE; 3.92%**), Apollo Global Management (APO; 3.07%**), and Fiserv (FI; 3.92%**). Overall, stock selection contributed favorably. The best result came from the portfolio's consumer discretionary names which gained 20.3% far ahead of their peers' rise of 6.9% led in large part by Dick's Sporting Goods (DKS; 2.71%**). Broadcom (AVGO; 4.10%**) and Flex (FLEX; 2.87%**) were the best contributors in information technology with the portfolio's holdings topping the group 15.1% versus 6.9% while General Electric highlighted in industrials. The portfolio also benefited from stock selection in health care, real estate, and financials. On the downside, the portfolio's communication services stocks were the biggest detractors falling -4.6% behind the group 8.1% gain due mostly to the overweighted Comcast (CMCSA; 2.99%**) and Warner Bros. Discovery†(WBD). Baker Hughes (BKR; 2.00%**) was an outlier in the energy space, the best performing group in the quarter, and was mostly responsible for the group's names lagging 8.0% versus 13.8%. Additional detractors included onsemi (ON; 0.99%**), Gilead (GILD; 1.70%**), and UPS (UPS; 2.01%**) though the portfolio's stocks in their respective sectors overall outperformed. Warner Bros. Discovery was eliminated during the quarter. Target, founded in 1902 and headquartered in Minneapolis, MN, is a general merchandise retailer selling products through its 2,000 stores and online. The company offers a collection of owned and exclusive brands as well as national brands and an assortment of food items. Owned brands include A New Day, Pillowfort, Cat & Jack, Goodfellow & Co., JoyLab, and Good & Gather. Exclusive partnerships include brands such as Apple,† Disney (DIS; 1.91%**), Levi's,† and Ulta Beauty.† At initiation, the stock had a $69.4 billion market capitalization and met all five valuation factors save for price-to-book. Since 1946, the company has given 5% of its profit to communities, changed its internal organization to bring all ESG efforts under one leader, and identified areas for sustainability improvement such as sourcing, chemical management, and packaging. The company targets to achieve zero waste to landfill in U.S. operations by 2030 and is committed to being a net zero enterprise by 2040. Catalysts for the investment are new management, restructuring, and new products/new markets. Target has been modernizing its supply chain operations to become a leading omnichannel retailer. The company expanded its digital fulfillment capabilities and will now focus on building out its regional distribution facilities. The company is also remodeling stores and opening smaller format stores in urban and college campus locations. These new smaller format locations are proving to be twice as productive as current locations. Early in 2024, the company announced the transition of 20-year Target veteran Michael Fiddelke to COO after serving as CFO since 2019, replacing long-time executive John Mulligan who will remain as a strategic advisor role through February 2025. Going back to its roots, Target recently announced a new partnership with Diane von Furstenberg with a limited- time collection of over 200 pieces spanning apparel, accessories, beauty and home, with most items under $50. The collection will offer made-to-order furniture starting at $300. Target continues to open Ulta Beauty shop-in-shops and expand Apple and Disney experiences. It has launched new owned brands, 11 of which are delivering over $1 billion in sales, including four which are delivering over $2 billion in sales, driven by strength in Apparel, Home Furnishings & Décor, and Food & Beverage. Given the infrastructure and leadership changes at the company, Target should see increased revenue and productivity, leading to increased cash flows, greater revenue generation, improving margins, and increased earnings which should yield significant upside over the next two years. The Walt Disney Co., headquartered in Burbank, CA, is engaged in the business of international family entertainment and media enterprise. The company owns and operates television and radio production, distribution and broadcasting stations, direct-to-consumer services, amusement parks, and hotels. It operates through the following business segments: Disney Entertainment, ESPN, and Disney Parks, Experiences, and Products. At initiation, the stock had a $202 billion market capitalization and met three valuation factors: price-to-sales, price-to-cash flow, and price-to- book. The fundamental catalyst is restructuring and cost reduction to improve DTC (Direct to Consumer) profitability. Additionally, the company has made initiatives to effective monetization of portfolio assets such as ESPN and introducing new content utilizing the considerable intellectual property (IP) within the company. These efforts should lead to increased cash flows and margins eventually resulting in improved earnings growth and ultimately notable upside over the next two years. Xylem, headquartered in Washington, D.C., is a water pump and technology company. Its products and services enable the use, conservation, transportation, and treatment of water. Examples include water and wastewater pumps, filtration, disinfection, treatment, valves, heat exchangers, controls, dispensers, smart meters, controls, and various sensors and devices. End markets include municipalities, utilities, industrial facilities, construction sites, and commercial/residential buildings. At initiation, the stock had a $27 billion market cap and met the highly price correlated valuation factor, price/ book. Currently, the stock has a yield of approximately 1.2%; the company has increased its dividend annually since it was spun out from ITT Industries† in 2011. Xylem's products and services help humanity improve water affordability, resilience, and reduce water scarcity. Fresh and potable water supply is increasingly under threat by increased pollution and drought conditions in many regions. Water affordability benefits from efficient delivery, infrastructure, use, and treatment of wastewater and clean water. One example of good corporate governance is Xylem Watermark, a program with a mission to enable healthy living through access to clean water, humanitarian disaster response, and other volunteering events. Catalysts are new management and restructuring. Xylem's CEO retired at year-end 2023 and is succeeded by COO Matthew Pine who has been with the company since 2020. The company also hired William Grogan from IDEXX Corp.† as CFO in October 2023. An upcoming investor event during the second quarter of 2024 should provide clarity on the new leadership team's medium term operational and financial goals. Xylem formally embarked on a lean operational improvement journey in 2020 that we think will be championed and intensified by the new CEO and CFO with constructive oversight from a recently appointed director who also embraces a lean mindset. Director Mark Morelli, CEO of Vontier,† joined Xylem's board in 2022. Additionally, in May 2023, Xylem acquired competitor Evoqua Water Technologies for approximately $7.5 billion in stock. This acquisition rounds out Xylem's industrial portfolio with Evoqua's leading water treatment solutions for the industrial sector complements Xylem's global portfolio. Xylem expects annualized cost synergies of $140 million by year end 2026 through procurement scale, facility consolidation, and public company G&A savings. We expect Xylem to scale Evoqua's capabilities globally and grow its recurring revenue streams. As the company improves its operating performance through its lean journey championed by new management and extracts synergies from its Evoqua acquisition, we think that the company is poised to improve cash flow, operating margins, and earnings meaningfully over the next few years. Juniper Networks, based in the Silicon Valley town of Sunnyvale, CA, Juniper is a leading provider of communications networking equipment, including switches, routers, security and IT orchestration services. At initiation, JNPR had a $9.2 billion market capitalization and met all five valuation factors. Juniper's Corporate Citizenship and Sustainability policies are guided by SASB materiality guidelines with a focus on the top 30% of stakeholder importance. Current areas of focus include ethics, data protection/privacy, inclusion and diversity, supply chain management, labor practices, ESG management, and reporting transparency, among others. The company adopted SBTi-based targets for Scope1+Scope2 emissions reductions targets of 18% by 2025 and 43% by 2035. The catalysts were strong/ new management and new markets/new products. To fill the newly created role of COO, the company tapped a former Juniper executive who departed to run a start-up security software company and rejoined Juniper through an acquisition, with all aspects of product development and marketing now reporting to a single leader. A new CTO came from Google†(and VMWare prior to that) where he led a team of engineers delivering networking infrastructure solutions to cloud customers. Management is now aligned from product strategy and development to marketing and the new structure should improve Juniper's pipeline development for sustained relevance. New products included the industry's first 400GB networking products, including proprietary silicon with embedded enhanced features, which should improve performance and cost. The company has also added new capabilities through a string of small acquisitions in artificial intelligence, security, and automation. The new management team and new product set positions the company well to attack the enterprise market and expand their addressable market. As these software- defined capabilities grow, margins should expand and the growing recurring revenue base should result in expanded valuation multiples. With these catalysts in place, Juniper should see an acceleration of earnings growth which should then lead to significant upside potential. Most recently, on January 9, 2024, Hewlett-Packard Enterprises† reached a definitive agreement to acquire Juniper for approximately $14 billion in an all-cash deal. Based on the likelihood the deal will be cleared, the position has limited upside and as such was completely sold. Keurig Dr Pepper Inc, headquartered in Burlington, MA, was founded in 2018 after the $18.7 billion merger deal combining Dr Pepper Snapple's drink and distribution network and Keurig Green Mountain's coffee business. KDP is a leading beverage company in North America with a diverse portfolio of flavored (non-cola) carbonated and non- carbonated beverages, ready-to-drink tea and coffee, juice drinks, mixers, and specialty coffee, and it is a producer of single serve brewing systems. Key owned brands include Dr Pepper, Canada Dry, Snapple, Evian, Vita Coco, Green Mountain, Keurig, and The Original Donut Shop. Keurig also collaborates with brands such as McCafe, Starbucks,† and Dunkin, as well as through private label with Kroger† and Kirkland. At initiation, the stock had a market capitalization of $49.2 billion and met two of the five valuation factors, price-to-book and dividend yield of 2.2%. The catalysts were cost cutting/restructuring, new market/new product, and new management. Although the refreshment beverages business has shown solid performance and momentum, notably through its partnership with Nutrabolt for C4 Energy, the company has not been able recover from its post-pandemic softness in the coffee business despite the launch of two new families of brewers (a cold coffee and a customizable modern coffee makers), holding KDP stock price down as a result. The decision was made to exit the position. Warner Brothers Discovery, headquartered in New York, NY is an American multinational mass media and entertainment conglomerate. The company is the result of the divestment of WarnerMedia by AT&T† and its merger with Discovery with trading of the new stock beginning on April 11, 2022. The merger was structured as a Reverse Morris Trust with AT&T shareholders holding a 71% interest in the new company's (WBD) stock. At elimination, the stock had a $21 billion market capitalization and met three of the five valuation factors: price-to-sales, price-to- cash flow, and price-to-book. The catalysts were new products/new markets, new management, and cost cutting. The combination of Discovery with its non-scripted content with Warner Media's news content media creates a powerful comprehensive media company with complementary offerings and a worldwide footprint. CEO David Zaslav has a long history of business execution. Despite management's success in the reduction of debt and improving cash flow through synergistic action resulting in increased free cash flow, we believe that due to the current macro environment impact on advertising and network business, it will take an extended time to deliver on the potential of WBD shares despite its long-term value. As such, the position was eliminated with the proceeds to be redirected to other investment opportunities. What may come as a surprise to some is the market is up year-to-date even without the benefit of Apple† outperformance. Strategas calculates that approximately one-fourth of the S&P 500 is at 52-week highs, a sign that participation is broader than it gets credit for. While growth stocks have outperformed year-to-date, real differentiation is occurring within the Magnificent 7 which started back in October 2023. Maybe the new moniker should be the Fab 4 headlined by Nvidia (NVDA),† Meta Platforms (META),† Amazon (AMZN),† and Microsoft (MSFT)† which were up 82%, 37%, 19%, and 12%, respectively, in the first quarter. The other three underperformed both the S&P and S&P IT returns of 11% and 13%, respectively; Alphabet (GOOG,GOOGL) was up 8%, Apple (AAPL) down -11%, and Tesla (TSLA) fell -19%. Amazon (AMZN) was added to the Dow Jones Industrial Average (DJIA) on February 26; this "honor" historically has not boded well for stocks being included. At the end of February, Apple was removed from Goldman Sachs's† conviction list although it kept its buy rating. The U.S. remains resilient with durable economic data along with cooling inflation. While other nations/economies are reporting anemic growth, U.S. growth has been expansive. The latest Atlanta Fed GDPNow estimate for 1Q:24 (April 3) was revised higher to 2.8% coming after the better than expected March ISM read. The unemployment rate and initial jobless claims are near historical lows, wage growth is outpacing CPI, and inflation is heading closer to the targeted 2%. Corporate balances sheets are also in great shape with the S&P 500 current ratio (Current Assets to Current Liabilities) at 1.3x and total debt-to-total assets at 26%; higher than the lows during Covid but less than the 20-year average of 28%. "This is a good situation, let's be honest, this is a good economy." - Fed Chair Powell. Fund deployment from the 2022 Inflation Reduction, 2021 Infrastructure Investment and Jobs, and 2023 Chips Acts is still to come along with IRS returns for Employee Retention Credits ('ERC') which could total $120 billion starting in April sustaining the economy and stock market. While the fruits of AI have been most clearly felt in the stock prices of Nvidia and others, many analysts believe Financials will be an early beneficiary of enhanced AI productivity. Reprogramming from old COBOL to modern languages may release banks from the shackles of waiting for overnight "batch reports" to get them close to real-time banking. JPMorgan Chase (JPM; 4.20%**) has been a leader as evidenced by earning the #1 spot in the Evident AI Index, the first public benchmark of major banks on their AI maturity, for the last two years. Many portfolio holdings directly benefit from AI implementation and many more benefit from its adoption and productivity increases. Blackrock (BLK)† estimates $6.5 trillion of cash on the sidelines and $2 trillion in CDs. This is likely to move once the Fed begins to cut rates. EPS estimates for 1Q:24 are for mid-single digits and are expected to rise to high single-digit/low double-digit growth for the next three quarters and again in 2025 with what we know today. Per UBS† research, S&P 500 Tech+ EPS comparisons peaked in 4Q:23 and are still quite strong throughout 2024. However, EPS growth excluding Tech+, bottomed in 2Q:23 and is poised for accelerating growth throughout 2024. The U.K. and Eurozone economies have experienced little to no growth over the past 5-7 quarters; the U.K. is technically in a recession while the Eurozone narrowly avoided one. Each is expected to grow in 2024 albeit sub 1% and less than the U.S. consensus of 1.5-2.5%. The Eurozone faces inflation risk due to geopolitics. However, inflation in the Eurozone fell to 2.4% y/y in March aided by lower energy prices though the services component remains sticky at 4%. Even so, the report is encouraging and further supports a rate cut in June. Germany is the largest laggard with expectations for tepid 0.3-0.7% growth in 2024. Inflation in the UK is at 3.4% y/y as of February. It is possible that the ECB and BoE cut before the Fed due to their tepid economic outlooks. With China targeting GDP growth of "around 5%," the PBOC announced it will allow banks to hold smaller reserves beginning February 5. Cutting the reserve requirement ration ('RRR') by 50 bps is estimated to release 1 trillion yuan (approximately $140 billion) in long-term capital. China is in the process of shoring up its banking industry by merging hundreds of rural lenders into regional behemoths. China fans are hopeful the government will roll out more stimulus after President Xi called for a boost in the sales of traditional consumer products. While deflation remains a risk, the latest CPI figure for February went positive (+0.7% y/y); it had been essentially flat or negative since April 2023. Materials prices have started to improve which could be a harbinger for the success of China's stimulus efforts. While still in its early stages, the BOJ's exit from its yield curve control and slightly lifting interest rates has not been positive for the value of the yen in relation to the USD. The recent Yen/USD slide indicates BOJ policy is still too loose and U.S. economic growth is stronger than expected. Increased rates in Japan could lead for repatriation of Japanese U.S. bond investors to buy closer to home unless U.S. yields remain more compelling. Japan's economy averted a technical recession with a small gain in 4Q:23. The country's inflation rate (which the BOJ has sought for years) rose to 2.8% in February and has exceeded the stated 2% target since April 2022. Investors have driven the Nikkei Index (NKY:IND) to its highest point in 34 years ago (when the country was at its economic peak) on March 22 and closed above 40,000 at quarter end. Risks abound. Neither the Israel/Hamas nor Ukraine/Russia wars show signs of easing. The Houthi rebels in Yemen are making the Red Sea shipping lane to the Suez Canal a dangerous path and forcing shippers to take much longer routes. The U.S. continues to be a global haven for all asset classes. Growth stocks had a banner year in 2023 after value's relative protection in 2022. The current extreme two standard deviation price-to-book and performance extremes of growth stocks versus value either connote reversion to the mean or the bar is so high for certain growth stocks that expectations may be difficult to surpass. Over time, valuations and earnings matter for stock prices. Value, as represented by the Russell 1000 Value, remains attractive at 16x next-twelve-month P/E and a commensurate 6.3% earnings yield which is greater than U.S. Treasury yields anywhere along the curve. We remain true to our diversified and disciplined portfolio strategy, diligent, and ever watchful for changes. Our base case is for the U.S. equity markets to go up which historically occurs 70% of the time. However, all portfolio holdings are stress tested for excessive leverage in case of a recession over the next two years and we completed a tariff macro stress test in the event of a Trump victory in November. We are busy and actively working to make the best portfolio decisions possible with the information we have and will adjust should the "facts" change. We are excited about the future but maintain strong risk controls for unexpected turbulent events. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

TCW Select Equities Fund Q2 2024 Commentary

The market outlook remains cautious with potential Fed rate cuts, geopolitical tensions, and a pending U.S. Presidential election influencing investment strategies. The Fund (MUTF:TGCEX, I Share) generated a net return of 7.49% during the second quarter, underperforming the Russell 1000® Growth Index return of +8.33%. Relative underperformance was primarily due to negative security selection effects (primarily in the information technology, consumer discretionary and healthcare sectors). YTD through the first half of CY24, The Fund (I Share) generated a return of +22.04%, outperforming the Russell 1000® Growth Index return of +20.70%. Outperformance was driven primarily by positive security selection effects. Equity markets generally moved higher in the second quarter. The NASDAQ advanced 8.3%, the S&P 500 (SP500,SPX) +4.3%, while the DJIA declined 1.7%. For the first half of 2024, the S&P 500 is +15.3% on a total return basis and continues to ratchet higher in the face of slowing economic growth. The price of crude oil was relatively flat during the quarter (-0.2%) but has increased 17.3% in 2024. For the quarter, gold was up 3.5% and +9.7% YTD. Signs of consumer weakness are emerging (discretionary spending, housing) and consumer sentiment is challenged (University of Michigan Consumer Sentiment Index dropped to 68.2 in June). The labor market is beginning to cool (4.1% in June unemployment rate, a 2½ year high), giving the Federal Reserve (Fed) cover to potentially cut rates in September. It is critical that the Fed does not loosen monetary policy too quickly to avoid the "stop-start" scenario of the 1970s. Globally, other central banks have begun their easing cycles (Swiss National Bank, Bank of Canada, European Central Bank), and it will be interesting to discern whether the Fed remains "data dependent" in the face of a U.S. Presidential election in the back half of the year. As the Fed has remained on hold, the USD has strengthened relative to several other currencies. The 2yr UST (US2Y) /10yr UST (US10Y) yield curve has been inverted for over two years (longest tenure on record), and historically this has almost always led to a recession. Geopolitical tensions remain high (China-U.S., Ukraine/Russia, Iran/ Israel) as we enter the important second-quarter corporate earnings season. Including the contribution of sector allocation and security selection, our information technology and consumer discretionary weightings hurt relative results most and our industrials and consumer staples weightings most positively impacted relative performance during 2Q24. Our strongest performance during the period came from the information technology and communication services sectors. Shares of Nvidia Corporation (NVDA; 14.18%**) continued their ascent after reporting strong quarterly results. Revenue of $26 billion (+262% YoY) topped consensus expectations and the company once again provided forward guidance well ahead of consensus. Management noted the demand for H200 and Blackwell exceeds supply, and that may remain the case well into next year. We believe the company's move to a one-year product launch cadence (from two previously) is helping to smooth supply/demand imbalances and assuage air pockets typically seen between product launches in the semiconductor industry. The company also announced a 10-for-1 stock split. We believe fundamentals remain strong and the company continues to fire on all cylinders. When we first purchased shares of NVDA almost six years ago, we believed the company was the beneficiary of multiple secular tailwinds and could become the "Wintel" of AI and Machine Learning. We believe our thesis is playing out as the company becomes a broad-based hardware/software platform and AI infrastructure company. Shares of Alphabet Inc. (GOOG; 7.20%**) moved higher after delivering strong quarterly results. Driven by strength in search (+15% YoY) as well as cloud (+29% YoY), the company beat consensus expectations, growth accelerated QoQ, and the company announced an additional $70 billion share repurchase authorization as well as the initiation of a dividend. As an "AI first company since 2016," the company has leaned into AI and Gen-AI enhancements and management noted a clear path to AI monetization via advertisements, cloud services and subscriptions. Capex was $12 billion in the quarter (+90% YoY) and management indicated it expects to invest at or above that quarterly amount over the course of the year. Despite stepped up investment, we are encouraged by management's tone around efficiency and shareholder returns. We remain constructive on shares. Our weakest relative performance during the period came from the healthcare and consumer discretionary sectors. Shares of DexCom, Inc. (DXCM; 1.85%**) underperformed in June due to some investors questioning the ramp of the company's upcoming commercial launch of Stelo, an over-the-counter 15-day cash-pay wearable Continuous Glucose Monitoring device targeted towards Type 2 diabetes patients currently not taking insulin. At DXCM's analyst event at the American Diabetes Association's conference held in late June, management did not provide pricing for Stelo, but we believe management's Stelo sales estimate in 2024 (~$40 million) may be conservative. Though shares have been volatile over the past year, our thesis remains intact that DXCM possesses a strong product advantage within an expanding end market. We remain constructive on shares. In the consumer discretionary sector, shares of Ulta Beauty, Inc. (ULTA; 1.18%**) dropped in the second quarter. In mid-March the company reported results for its fiscal fourth quarter 2023, and while earnings and comparable sales estimates beat consensus expectations, management's guidance was back-half loaded, concerning some investors. Then at an investment conference in early April (three weeks later), management noted a slowdown across price points and segments with growth decelerating much quicker than previously anticipated, further pressuring ULTA's share price. Understandably, management's credibility in forecasting its business has been hit. In late May, the company's fiscal first quarter 2024 results were released and EPS topped consensus estimates, with comp trends similar to those experienced the prior quarter. Accordingly, management elected to lower forward revenue, EPS, operating margin, and comp guidance. On a valuation basis, the stock is relatively inexpensive on an earnings basis given the industry and company-headwinds faced by ULTA. As an off-mall retailer with a loyal customer base (over 42 million Ulta Rewards members), we recognize the current challenges and are closely monitoring the situation. Cadence Design Systems, Inc. (CDNS; Information Technology) (1.53%**) - Cadence provides EDA (Electronic Design Automation) software, hardware, and IP blocks used by engineers to design semiconductors. Long-wave secular trends (Generative AI, hyperscale computing, autonomous driving, 5G) are driving demand for increasingly complex semiconductors and CDNS is a key enabler in the design of these chips. Cadence is one of only two companies offering full-design flow solutions leading to sizable market share, a sticky customer base and a rational competitive landscape. Healthy end market growth, constant demand for more sophisticated solutions and pricing power lead to attractive top-line growth, and the increasingly subscription-based business model (provides high revenue visibility with ~85% recurring revenues) further enable attractive economics. We believe the current share price does not reflect the long-term earnings power of the company. Shopify Inc. (SHOP; Information Technology) (1.62%**) - Shopify Inc. is a global cloud-based online commerce company platform that provides tools and services to over two million businesses in over 175 countries. Its platform enables merchants to manage products, fulfill and ship orders, build and enhance customer relationships, leverage analytics, manage payments, access financing, as well as buy advertising through its platform. Shopify (currently the #2 online e-commerce platform in the U.S.) operates in two segments: Subscription Solutions (~1/4 of revenues) and Merchant Solutions (~3/4 of revenues). We are attracted to the company's accelerating market share capture, capital-light business model, pricing power and leverage to the secular trend of Direct-to-Consumer retail. We have followed Shopify closely for years and believe the current share price does not reflect the long-term margin expansion and earnings power of the company. GE Aerospace (GE; Industrials) (0.70%**) - GE Aerospace (formerly General Electric Company after the April 2024 spinoff of its power and renewable assets business) is the largest aircraft engine supplier in the world. At any given time, its engines power three out of every four flights. The company operates in two segments: Commercial Engines & Services (~75% of revenues and ~86% of profits) and Defense & Propulsion Technologies (~25% of revenues and ~14% of profits). We are attracted to the oligopolistic aerospace market as it is characterized by limited competition and high barriers to entry (capital intensive, safety regulations, R&D/IP design expertise critical). The business model is the classic "razor-razor blade" model whereby GE makes little to no profit on the initial engine sale, and makes its money on aftermarket service, resulting in long duration, recurring cash flows. Industry dynamics are currently favorable with OEM demand exceeding supply (capacity has not yet recovered to pre-pandemic levels), and with ~80% of global aircraft past the five-year warranty window and needing to fly longer, we believe GE's highly profitable aftermarket services business is poised to benefit. We believe the current stock price does not adequately reflect the strength of GE's business model, balance sheet, management team and free cash flow profile of the company. NIKE, Inc. (NKE; Consumer Discretionary) - Nike, the largest seller of athletic footwear and apparel in the world, sells its products to consumers through Nike-owned retail stores, digital platforms, retail accounts and a mix of independent distributors, licensees and sales representatives in virtually all countries around the world. When we first purchased shares, we were attracted to the company's digital transformation and mix shift to more direct and digital distribution channels, which we believed could create a better flywheel with more customer data enabling better product and more targeted marketing. With fewer intermediaries, Nike would also enjoy better economics through more full-pricing selling at better margins. Due to a series of management missteps, lackluster product innovation over the past few years, as well as increasing competition, we elected to sell our shares to fund more attractive ideas. The Charles Schwab Corporation (SCHW; Financials) - Charles Schwab is a financial services company that primarily provides securities brokerage, money management and financial advisory services to individual investors and independent investment advisors. When we first purchased shares, we were attracted to the company's scale, technology, low cost offering and asset gathering capabilities. After nearly a decade of ownership though, the growth rates of the business have decelerated to the lower end of our portfolio and the stock has approached our long-term price target. Accordingly, we have been using the position as a source of cash and recently sold the last of our position to fund ideas we believe provide more upside over the next three-to-five years. "Keegan Bradley? Really?" So began a recent team meeting. For non-golf fans, Keegan Bradley was recently announced as the surprise pick for 2025 U.S. Ryder Cup team captain. Established in 1927, the biannual Ryder Cup event is a series of golf matches over three days between the U.S. and Europe and is viewed as the preeminent golf team event in what is otherwise a very individual sport. While largely a ceremonial golf event (no prize money, 17" trophy awarded to the winning team), making the team is a career goal for many professional golfers. As captain, Mr. Bradley will set the tone for the U.S., and will be presented with several difficult decisions over the next year, including selecting his players. As our team discussed the challenges of being a Ryder Cup captain, we began to see parallels to portfolio management. The captain (PM) must pick the players (stocks), optimize the team (portfolio construction) and consider unknowns well in advance like the potential weather conditions (market environment). Although six of the 12 players on the U.S. team automatically qualify via points earned, the Ryder team captain is charged with picking the remaining six. Many times those remaining players are consensus picks, but we are reminded of the payoff from a non-consensus pick in 2021 by Captain Steve Stricker. He passed over two higher-ranked players (Patrick Reed and Webb Simpson) to select a 25-year old named Scottie Scheffler. While Reed and Simpson had won numerous times on tour (and each had won a major championship), Scheffler had yet to card a professional win. We speculate Mr. Stricker's decision had less to do with what Scheffler had done, and more to do with his potential. This non-consensus pick paid off as Scheffler won two matches, tied one and is now the #1 ranked player in the world with 12 career wins, including two major championships. We seek to emulate Captain Stricker by focusing more on a business's potential than just recent results and looking for the non-consensus opportunities. We measure business potential across two primary dimensions, business model advantage ('BMA') and total addressable market ('TAM'). The greater and more sustainable the competitive advantage and the larger the end market opportunity available to perpetuate those advantages, the greater the potential for long-term value creation. While we are bullish on the potential of all the businesses we own, we'd characterize members of the Magnificent 7 as either automatic qualifiers or consensus picks in Ryder Cup terms. Yes, they form a key part of the portfolio, but alpha is much more likely to be driven by our remaining team picks over the coming years. As we have said before, we view our portfolio as so much more than the Magnificent 7. In selecting the players, the captain must also consider team construction. Ideally, the captain will blend the strengths, weaknesses, and personalities of a diverse group and will have an eye on the present (winning now) as well as the future (experience for future Ryder Cups). A good captain recognizes that a Scottie Scheffler can be a good bet if the team is also stacked with veterans like then-37-year old Dustin Johnson (who proceeded to go 5-0-0 in 2021). Each player on the team has a role to play, just as each stock in our portfolio provides different exposures, growth profiles and macro-economic sensitivities. Blending companies with businesses less correlated to GDP to a stable of offensive growth stocks has been an important element of our portfolio construction over the past fifteen years+. However, we also seek to combine businesses with different end market demand drivers, stages of profitability and ranges of outcomes so we can enhance the probability of performing well today and in future years without requiring turnover of the entire portfolio. Stocks, just like players can have slumps and we believe it is important to not try to overmanage stocks seeing drawdowns if our conviction in the BMA and TAM remain high. Many of our most successful investments have experienced sharp periodic drawdowns before seeing outsized appreciation. As an investor once said to us,"Think of how many times over the past 15 years, you had to convince yourself not to sell the stock." We own five of the Magnificent 7 stocks and are comfortable with these team veterans. However, we anticipate that market indices will not always be so reliant on them for performance and that they are not immune from periodic slumps. Hence, we have a broad bench of other offensive and defensive positions to benefit from later waves of AI investment or other secular trends like Data as the New Currency, Cybersecurity, or the Electronification of Payments. We also have next generation winners ready to take more of the growth baton from the Magnificent 7 like Shopify outgrowing Amazon (AMZN; 6.43%**) in ecommerce or The Trade Desk (TTD; 1.97%**) surpassing the growth of GOOG and META (META; 3.28%**) in digital advertising. Like a good captain, we are positioning for both current and future performance. While the captain (and PM) aims to stack the deck in their favor through player selection and team construction, variables like weather conditions can test some of those decisions when play begins. Adaptability and resiliency can become as important as skill or raw potential in such cases. Our approach, as referenced in our Q4 2023 letter, is to go with "all-mountain skis" rather than rely more heavily on our weather forecasting abilities. We can make adjustments as we go but our ultimate success is largely determined by the resiliency built into the portfolio before the weather turns. Do we have enough players that can play well in each potential weather scenario we can foresee? Do we have players that can be successful in multiple environments? That's where we spend much of our time when overlaying the macro onto the portfolio construction process. With this caveat that we are not overly anchored to a single macroeconomic outlook, what is the current weather forecast from our vantage point? The Fed remains "data dependent" and seemingly wants to avoid the "stop and go" policy of the 1970s. Inflation is continuing to cool, job openings have dropped meaningfully (~8 million, down from ~12 million in March 2022) but deterioration in employment is still modest, and GDP growth is still positive, but moderating in the U.S. (1Q24 +1.4% and trending to ~+1.5% in 2Q24). Against this backdrop, we believe June's CPI (Consumer Price Index) print provides cover for the Fed to potentially ease in September. Fed Chair Powell noted in his recent testimony that "elevated inflation is not the only risk we face." As we have stated in numerous prior commentaries, equities generally perform well during a "Fed pause" and the current period marks the second longest on record (only 2006-2007 longer). Once the Fed starts cutting though, the picture is mixed. After initial pullbacks, markets have continued to grind higher in cutting cycles like 1984, 1995 and 2019 when the economy avoided a recession, but the first cut often marks the beginning of more extended declines in periods where a recession is in the offing. We are keenly aware that the 2yr UST/10yr UST has been inverted for two years (longest tenure in recorded data), and historically this has almost always led to a recession. Ultimately, just as we cannot predict whether Keegan Bradley will be able to produce a victory at Bethpage Black in 2025 and replicate Steve Stricker's success in 2021 (weather was calm and the U.S. Ryder Cup team routed Europe 19-9), we cannot predict near-term market gyrations. Accordingly, we do not make binary bets on any one scenario, even our base case. While we consider the current market environment, the primary driver of our portfolio returns has always been the micro fundamentals of each of the businesses we own. Whether or not the micro fundamentals are more (an offensive position) or less (a defensive position) correlated with GDP, we seek businesses with similarly differentiated business model quality and growth opportunities. The value of the longer-term potential of these businesses is more important than how they may perform over the next several quarters. We readily admit that our macro perspective has routinely led us to trade off some potential upside from purely pro-cyclical positions to dampen enduring downside risk with businesses that benefit from less correlated fundamentals. But, with a pending U.S. Presidential election and potential Fed pivot, the weather can change in a heartbeat. As always, we remain truly grateful for your trust and support, Brandon D. Bond, CFA Managing Director Portfolio Manager Equities Brian M. McNamarak, Managing Director Analyst and Portfolio Specialist Equities Robert J. Park, CFA Managing Director Senior Analyst Equities Craig C. Blum, CFA Group Managing Director Senior Portfolio Advisor Equities Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.