The S&P 500’s modest gain of 0.18% for May obscures a more volatile period in which the benchmark briefly touched bear market territory, declining 20% on a year-to-date basis, before staging a partial recovery. The Federal Reserve faces the challenge of taming inflation without extinguishing growth following the disconnect between a robust economic backdrop and poor equity returns.
For the month, the BBH US Large Cap Equity Composite (“US Large Cap Equity” or “the Strategy”) declined -0.83%. The Strategy’s top contributor was auto insurer Progressive (PGR), gaining 11.20%, and the largest detractor was warehouse club retailer Costco (COST), declining 12.32%. Materials and Information Technology were the leading sector contributors, while Consumer Discretionary and Staples were the largest sector detractors. During the period we initiated a new position in digital media software provider Adobe (ADBE) and sold specialty coffee retailer Starbucks (SBUX). The Strategy ended the period with 30 positions and 1.27% in cash.
Insurance holdings Berkshire Hathaway (BRK.B), Arthur J. Gallagher (AJG), and Progressive have been strong portfolio performers over the past year. Progressive, being the top Strategy contributor on a one month, year-to-date and trailing 12-month basis, reflects this best-in-class insurer’s recovering underwriting profitability.
Shares of Costco and other major retailers came under pressure mid-month when Target (TGT) and Walmart (WMT) reported disappointing results exhibiting margin pressure and changing consumer behavior. While Costco’s business is not immune to these factors, their inventory management and membership driven business model position it well on a relative basis.
We initiated a position in Adobe, a software provider that plays a critical role in enabling the economy’s digital transformation, content proliferation, marketing, and e-commerce with industry-leading unit economics. Adobe’s front-office software enjoys excellent margins, strong free cash flow generation, and attractive returns on invested capital.
We exited our investment in Starbucks primarily due to an unexpected and protracted leadership transition. Additionally, an uncertain backdrop driven by labor, increasing investments, and the resurgence of strict COVID restrictions in China are further challenges the business must navigate in the near term leading to a wider range of outcomes than we had anticipated.