“Equities have had a fast start in 2024, particularly with the further appreciation of growth equities during the quarter.”
Jennison Associates, LLC
Market in Review
Overall, the market environment during the first quarter of 2024 reflected similar trends that closed out 2023, with investor sentiment and company fundamentals trending positively. Equities gained despite a pushback in the timing and magnitude of expected cuts in the U.S. federal funds rate. The changing funds rate dynamic came as growth, employment, and inflation all mildly surprised to the upside. The 10-year U.S. Treasury bond yields moved higher throughout the quarter, while oil prices rebounded by approximately 10% at the start of the year.
Global economic growth varied by region. U.S. growth remained above other major geographies, continuing recent trends. Japan exited a decades-long period of negative interest rates amid optimism about higher levels of expected growth, leading the yen lower against other major currencies. Elsewhere, European economies remained hostage to low levels of activity and the ongoing overhang of the war in Ukraine, now entering its third year. China's ongoing attempts to address domestic real estate weakness showed little progress, while sentiment and activity levels reflected these concerns. Meanwhile, pressure around technology trade and transfer agreements between China and the West continued to build.
Enthusiasm around generative artificial intelligence (AI) continued on pace, with semiconductors — the primary building blocks of AI capabilities — which continues to be the focus of attention. Undersupply of leading-edge GPU processors, expanding applications of generative AI to industries beyond technology, and the issues around capacity to construct and power the required datacenter infrastructure framed the backdrop to another quarter of outperformance for the companies we believe may be best positioned to benefit from these trends.
Portfolio Performance
During the quarter, the Harbor Capital Appreciation Fund (Trades, Portfolio) (Institutional Class, “Fund”) returned 13.72%, outperforming its benchmarks, the Russell 1000® Growth Index, which returned 11.41%, and the S&P 500 Index, which returned 10.56%.
Stock selection within the Information Technology, Health Care, and Communication Services sectors was particularly additive to relative results during the quarter.
Positions within Consumer Discretionary detracted the most from relative results.
Contributors & Detractors
NVIDIA (NVDA, Financial) contributed to performance and reported another strong quarter, with even more acceleration in its datacenter segment. Demand continues to remain well ahead of supply.
Meta Platforms (META, Financial) also contributed to performance. The company continues to benefit from an improved advertising market and recommendation engine, as well as share gains.
AI and ad stack improvements should be multiyear tailwinds.
Tesla (TSLA, Financial) detracted from performance during the quarter. Although earnings were in line with guidance, the stock declined on less visibility into volume and gross margins.
Apple (AAPL, Financial) also detracted from performance, as the company reduced first quarter 2024 revenue guidance due to COVID-19-affected comparisons. In addition, China continues to underperform with a 13% drop in last quarter's sales.
Buys & Sells
During the quarter, we initiated a new position in Disney (DIS, Financial), as it is one of the few legacy media companies that is successfully transitioning its business into streaming. Its ability to create new intellectual property (IP) and essentially turn it into a recurring revenue stream through the “Experience” business (Parks & Consumer Products) — and now the streaming business — appears to be setting it apart.
During the quarter, we sold ARM Holdings (ARM, Financial). The company has been a beneficiary of the unprecedented demand for semiconductors driven by generative AI. We eliminated our position as performance has been very strong since ARM's IPO, and shares have greatly exceeded our price target.
Overweights & Underweights
Sector weights are a by-product of our research-based stock selection. At the beginning of 2024, the Fund's largest sector overweights/underweights relative to the Russell 1000® Growth Index were in Consumer Discretionary (overweight) and Information Technology (underweight). Market volatility impacted the Fund's weights during the quarter, but active sector weights were generally stable and directionally consistent throughout the quarter.
Outlook
Equities have had a fast start in 2024, particularly with the further appreciation of growth equities during the quarter. We can trace these returns to broader themes that have been at play for the past several quarters — namely, enthusiasm for generative AI and the ongoing growth of GLP-1 drugs for weight loss related to diabetes treatment. More broadly, we are forecasting accelerating earnings growth in 2024 compared to last year, and at a premium to consensus forecast gains for the Russell 1000® Growth Index and the broader S&P 500 Index. Economic activity and associated service-related inflation measures in the first quarter came in at higher levels than broadly forecast at the start of the year, leading to a reduction in the expected pace and scope of reductions in the federal funds rate at the end of the first quarter. While macroeconomic variables do not drive our investment process, they do shape investor expectations and behavior. The narrative around a slowing economy and the possibility of outright recession have waxed and waned over the past year, with investors attempting to gauge the impacts of the Fed tightening cycle that started in 2022. History suggests these impacts lag actual activity levels by as much as 18 months to two years. Given this historical context, fewer analysts now expect a recession, which partly speaks to the changed interest rate landscape since the year began.
Abundant liquidity, a banking system that has withstood significant stress following last year's high-profile failures and continued favorable employment-market dynamics point to an environment of stronger U.S. economic growth, though at lower levels than in the previous few years. The nature of our discussions with the managements of the companies that we own in the fund are reflective of this outlook. We believe the fund could have durable growth opportunities and growth ability. We think they could be well positioned to benefit further as generative AI adoption proliferates across industries, though we are still at the very early stages of this adoption curve. Our core positioning within select semiconductor and software holdings reflects our conviction in this thesis, while we have made further adjustments to capture greater opportunity and simultaneously harvest a portion of the gains in others.
