Wells Fargo Compass Advisory Program Current Equity Income Portfolio

Transcription

1 Wells Fargo Advisors Portfolio Management Quarterly Commentary Wells Fargo Compass Advisory Program Current Equity Income Portfolio December 31, 2017 Chris Hanaway, CFA Co-Portfolio Manager Jack Spudich, CFA Co-Portfolio Manager Summary» Fourth-quarter 2017 portfolio performance was +5.65% compared to +6.64% for the benchmark S&P 500.» The strong performance of lower-yielding Technology and Internet Retail stocks was an important contributor to relative portfolio performance in the fourth quarter.» Full-year 2017 portfolio performance was % compared to % for the benchmark S&P 500.» Similar to the fourth quarter of 2017, the strong performance of lower-yielding Technology and Internet Retail stocks was an important contributor to portfolio performance for the full year.» For the fourth-quarter 2017, seven companies held in the portfolio announced dividend increases. The average annualized increase was 4.50%.» For the full-year 2017, 44 dividend increases were announced with an average annualized increase of 6.0%. Fourth Quarter 2017 Market Commentary Equity and bond returns were generally positive for 2017, reflecting a year of synchronized global growth and benign inflation. Consistent with the views of the Wells Fargo Investment Institute (WFII), we think improving fundamentals could validate asset prices after the strong 2017 returns. More supportive fiscal policy and less economic uncertainty could mean that markets could continue to improve even with somewhat tighter monetary policy. We do not expect a credit contraction or a reversal of earnings growth over the next year, but we recognize that global recovery is in the later stages. This could mean higher market volatility and more modest returns going forward. Better earnings supported positive returns for U.S. equities for the year. According to Wells Fargo Investment Institute (WFII) data, S&P 500 earnings for the year could grow 10% for 2017, when final figures are in. The S&P 500 was +21.8% for the year. U.S. Mid-Cap equities were +18.5%, as measured by the Russell Mid-Cap Index. U.S. Small-Caps were +14.7%, as measured by the Russell 2000 Index (FactSet). We would characterize valuations as fair and would not be surprised to see more modest returns in the near term. We remain positive on the longer-term prospects for domestic stocks, primarily because the outlook for earnings growth remains positive. Emerging Market Equities were +37.3% for the year as measured by the MSCI Emerging Market Index. Developed Market Equities were +25.0% as measured by MSCI EAFE Index. According to Bloomberg data, earnings per share growth from continuing operations for the first nine months of the year was +21% for MSCI Emerging Market and +16% for Developed Market Equities (MSCI EAFE). Multiples expanded somewhat, but even after a year of strong performance both indices appear to us attractively valued. Please see pages 4-5 of this report for Disclosures Page 1 of 5

2 Bond total returns were broadly positive for the year. We think this was a bit of a surprise for fixed income investors. Long-term interest rates fell due to lower inflation expectations. The yield on the U.S. 30 year Treasury fell 33 basis points for the year. ( One basis point equals 1%.) Investment grade and high yield bonds outperformed Treasuries, because better economic growth meant a reduced risk of distress for credit sensitive debt. For dollar investors, non-u.s. bonds generally performed well relative to U.S. Treasuries and in absolute terms. By the end of the year, oil markets had recovered nicely from the lows in mid-summer, but prices could continue to trade within a band. Real Estate Investment Trusts (REITS) were positive for the year. In terms of risks, we see a mix of cross currents characterizing the next 12 months. These include the outlook for inflation, the path of the credit cycle, 2018 mid-term elections, evolving regulatory changes, and geopolitical challenges. We begin 2018 about half way through year 9 of the second longest U.S. expansion on record. We would expect an increase in volatility after a relatively quiet Investors need to pay close attention to risks, but they should also recognize that fundamentals are broadly positive. In our view, calls for a sharp setback followed by sustained weakness contradict a range of data, which includes improving profits, continued policy support, and less political uncertainty in a number of regions across the globe. Portfolio Commentary The total return for Current Equity Income for the fourth quarter of 2017 was +5.65% compared with +6.64% for the S&P 500. The strong performance of the low yielding Information Technology and Internet Retail stocks that are part of the benchmark was an important factor in relative performance. Many of these stocks either do not pay a dividend or pay a relatively small dividend. These stocks do not fit the objectives of the portfolio, which call for an above-market average yield accompanied by dividend growth. For the quarter, the Health Care sector, up +1.46%, was a positive contributor to relative returns. Energy, up +6.02%, was also a positive contributor. Of the higher yielding sectors of the S&P 500, Telecom Services was +3.61%, Utilities were +0.21%, and Consumer Staples was +6.49%. (Bloomberg) The total return for Current Equity Income for the full year of 2017 was compared to % for the S&P 500. Similar to the fourth-quarter results, the strong performances of the low-yielding Information Technology stocks was an important factor in relative performance. For the full year, the Consumer Discretionary sector, %, was a positive contributor to relative returns. Energy, -0.99%, was also a positive contributor. Of the higher yielding sectors of the S&P 500, Telecom Services was -1.25%, Utilities were %, and Consumer Staples was %. (Bloomberg) We think that dividend paying equities could continue to provide attractive total returns for long-term investors. First, we do not expect materially higher interest rates in the near term. The yield on the U.S. 10- year. Treasury note ended the quarter at 2.45%. (Bloomberg) For context, WFII s 2018 year-end target for the 10-year U.S. Treasury note is 2.50%-3.00%, not significantly higher, in our opinion, than where rates are now. We expect interest rates to move higher, because global economic growth is better than it has been for the last few years. However, though demand appears to be improving across the globe, the recovery is still at a stage where it needs the support of accommodative monetary policy. This means that rates could remain near current levels for an extended period. Second, improving global growth, as pointed out by WFII, could improve the ability of well-positioned companies to generate the excess capital needed to pay and grow dividends. Many companies have had to control costs and make their operations more efficient during this slower recovery. Higher spending and Page 2 of 5

3 more jobs across the globe could benefit the sales and earnings of well-positioned and well-managed companies. That in turn could translate into better cash flows and cash returns to shareholders. Our performance this quarter is evidence that we are sticking to our mandate. Our marching orders are to provide an attractive total return over time by investing in a portfolio of equities that has an above-market dividend yield with the potential for dividend growth. For the full year 2017, stocks in the S&P 500 that do not pay a dividend were up about % on a market-capitalization weighted basis compared with % for the index as a whole. (Bloomberg) An important part of our strategy is to keep the portfolio turnover low and focus on what we believe to be relatively stable, well-positioned businesses. The yield mandate and strategy of Current Equity Income may lead to underperformance in some periods, however, we think that over time the strategy of focusing on above market dividend yield with sustainable growth characteristics has the potential to provide attractive returns for investors. Dividend News Eight companies held in the portfolio announced dividend increases during the fourth quarter. The average annualized increase was +4.50%. Year-to-date 44 dividend increases have been announced with an average increase of 6.0%. At quarter end, the dividend yield was 2.73% compared to 1.97% for the S&P 500. Dividend Announcements (October 1, 2017 December 31, 2017) Year Earlier New Annual Annual Annualized Important Company Symbol Dividend Rate Dividend Rate Increase Disclosures* AbbVie Inc. ABBV $2.84 $ % FSU American Electric Power AEP $2.48 $ % BFMSUZ AT&T Inc. T $2.00 $ % BFMSUY Dominion Energy Inc. D $3.34 $ % BFMSUYZ International Paper Co. IP $1.90 $ % FSUZ Microchip Technology Inc. MCHP $1.45 $ % BFMSUZ Nucor Corp. NUE $1.52 $ % FSUYZ Pfizer Inc. PFE $1.36 $ % DFSU Average 4.5% Sources: Company reports, Wells Fargo Advisors * Please see page 5 for legend disclosures. Portfolio Statistics (as of December 31, 2017) Number of Holdings 42* Median Price to Book 4.1X Median Market Capitalization $81.4B Median Return on Equity 16.8% Median P/E (forward 12 months) 19.0X Average Portfolio Dividend Yield** 2.9% Median 3-5 Year EPS Growth 8.4% * Excludes cash position Source: FactSet **Weighted average of all portfolio holdings Past performance is no guarantee of future results. The Dividend yield does not represent the return of the portfolio. Page 3 of 5

4 Source: FactSet IMPORTANT DISCLOSURES B D F M S U Y Z Wells Fargo Advisors or an affiliate has received compensation for investment banking services within the past 12 months. An employee of Wells Fargo Advisors or an affiliate is an officer, director or advisory board member. Wells Fargo Advisors or an affiliate has a significant financial interest in the issuer. Wells Fargo Advisors or an affiliate has managed/co-managed a public offering within the past 12 months. Wells Fargo Advisors or an affiliate expects to receive or intends to seek compensation for investment banking services within the next three months. Wells Fargo Advisors or an affiliate has beneficial ownership of 0.5% or more of any class of the common stock Wells Fargo Advisors or an affiliate received compensation from the subject company for products or services other than investment banking services during the past 12 months. Wells Fargo Advisors or an affiliate owns 1% or more of the equity or equity equivalents. Risk Considerations The Portfolio s equity investments are subject to market risk which means their value may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Investments in equity securities are generally more volatile than other types of securities. There is no guarantee that dividend-paying stocks will return more than the overall stock market. Dividends are not guaranteed and are subject to change or elimination. Technology and Internet-related stocks, especially of smaller, less-seasoned companies, tend to be more volatile than the overall market. The prices of small and mid-cap company stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions. Page 4 of 5

5 There are special risks associated with an investment in real estate, including the possible illiquidity of the underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions. Index Definitions An index is not managed and is unavailable for direct investment. MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index. Russell Midcap Index measures the performance of the 800 smallest companies in the Russell 1000 Index. S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the US stock market. General Disclosures The Wells Fargo Compass Advisory program is not designed for excessively traded or inactive accounts and may not be suitable for all investors. Please carefully review the Wells Fargo Advisors advisory disclosure document for a full description of our services. The minimum account size for this program is between $50,000 and $200,000. The minimum account size for the Current Equity Income portfolio is $50,000. The Current Equity Income Portfolio started in the Wells Fargo Compass Advisory Program beginning June 20, Additional information available upon request. Past performance is not a guide to future performance. The material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee as to its accuracy or completeness. This material is published solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or investment product. Opinions and estimates are as of a certain date and subject to change without notice. Wells Fargo Advisors is registered with the U.S. Securities Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Wells Fargo Investment Institute, Inc. is a registered investment adviser and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company Wells Fargo Clearing Services, LLC. All rights reserved Page 5 of 5