21 Apr 2012 Thornburg Value Fund - Q1 2012 Commentary ( Portfolio )
During the quarter, the portfolio benefitted from an overweight position and positive stock selection in the financials sector. Following a difficult 2011, financials have been the best performers this year. Positive stock selection in the healthcare and consumer discretionary sectors also contributed. Four of the top five contributors — Bank of America Corporation, Gilead Sciences, Inc., Thermo Fisher Scientific, Inc., and The Gap, Inc — were in these sectors. Level 3 Communications, Inc. rounded out the top five contributors.

Investors responded to positive news from the banking sector as the Federal Reserve released encouraging results of its stress test of 19 of the nation’s largest banks. A recovering U.S. economy provides a strong tailwind for the banks, but even after robust first-quarter performance, the sector remains cheap. Investors in Bank of America were encouraged when it reported positive fourth quarter net income, helping reverse earlier losses.

Gilead Sciences experienced a volatile first quarter as the stock at first reacted favorably to what looked like tremendous early results in a Hepatitis C trial. It gave back some of the gains when follow-up from the same trial showed that most patients relapsed. Results so far from the newly acquired HCV compound remain encouraging, and add upside to what we believe is a steady, underappreciated HIV franchise. Thermo Fisher reported record fourth quarter and full-year 2011 results, aided by significant product launches across all three business segments and expansion in highgrowth emerging markets including China, India, and Brazil. Thermo Fisher, a consistent earner with a varied customer base, was down last year with the market.

The Gap performed well, as its spring product line seems to be resonating with consumers. Level 3 raised earnings guidance for the year 2012, and after acquiring Global Crossing, the firm has a lower risk profile.

Stocks in the information technology and energy sectors detracted from performance, including Yahoo!, Inc., Google, Inc., MEMC/SunEdison Electronic Materials, SandRidge Energy, Inc., and Alpha Natural Resources, Inc. Yahoo’s reported fourth quarter and full-year 2011 results missed estimates, and management issued weak guidance. But we are excited about the prospects for improvement in its U.S. business — with a new CEO and revived board leadership. The upside driver at Yahoo is the growth in Alibaba Group, a private Chinese internet company in which Yahoo holds a large investment.
Google, which was flat during the quarter, did not keep up with strong information technology sector performance or the broad U.S. market. It reported strong results for the third quarter in October and traded well following that news, but expectations were too high headed into the fourth quarter report. Year-over-year revenue growth of 28% didn’t meet expectations, and the stock returned some gains. MEMC missed Q4 revenue estimates and issued Q1 2012 earnings-per-share guidance below expectations. We believe semi-wafer volumes will improve as overall consumer electronics demand improves. As demand for tablets, smart phones, and PCs grows, so will demand for MEMC’s semi-wafers. In addition, the solar installation project pipeline has been growing recently. We believe sales should increase over the next twelve months as this pipeline is converted into completed installation projects.

SandRidge also pulled back after strong fourth quarter performance. The market has been skeptical of the announcement to acquire Dynamic Offshore Resources, as SandRidge has historically focused on drilling onshore and the acquisition of an offshore company is outside its area of expertise. Alpha Natural Resources, purchased during the quarter, rounded out the bottom five.

Purchases during the quarter included Delphi Automotive plc, Citigroup, and Alpha Natural Resources. Delphi is a global vehicle components manufacturer that supplies original equipment manufacturers throughout the world. The company completed its IPO in November 2011 following a bankruptcy restructuring. The restructuring substantially reduced its legacy costs and realigned its manufacturing footprint, leaving it with strong positions in core businesses. Citigroup, a diversified financial services holding company, has an unparalleled global franchise and a unique ability to capture the banking revenues associated with trade flows — and handle the cash management business of corporations. We believe the realignment of the U.S. business and redeployment of capital into businesses with potential for higher returns and faster growth will lead to favorable results over time. Alpha Natural Resources is a leading producer of metallurgical (MET) coal, which is used in steel production. Although the price of MET coal has recently declined, we believe the pricing outlook over the intermediate to long term is favorable. We believe that in a normal MET coal price environment, Alpha Natural Resources will generate earnings and cash flow that justify meaningful share price appreciation.

Sales during the quarter included Corning, Inc. and Hewlett Packard Company. Corning is facing two new competitive entries in the LCD glass business, where growth has slowed as the transition from CRT and Plasma to LCD is nearly complete. Samsung is working on a technology that has the potential to halve the amount of glass required to manufacture a television. Finally, Hewlett Packard’s recent very weak operations performance and depressed future earnings outlook challenged our investment thesis.

In general, investors sought to reduce risk during 2010 and 2011. This was reflected in the behavior of long-term interest rates and in the high relative returns achieved by safe-haven consumer staples and utilities stocks. Certain metrics reflective of risk aversion went to greater extremes than we have seen during the past 50 years. Our view is that this investor behavior constituted a panic, and that fixed income assets, cash, and other havens are over-valued and are crowded trades. We believe we are in the early stages of an unwind of such panic-driven flows, and that many stocks that were discounted during 2010 and 2011 have the potential to appreciate significantly.

The value proposition of equities relative to fixed income is the best that it has been in decades; as confidence returns, the money should return to stocks. The 5% real earnings yield (taking inflation into account) of the S&P 500 Index today looks very attractive relative to real 10-year government bond yields, which are slightly negative, or real Baa corporate bond yields, which are around 2.5%. After a decade of weak returns for equities, individual investor expectations have soured for this asset class. With highly skeptical investors, attractive valuations, and unprecedented quantities of capital allocated to cash and fixed income, we believe the potential for equity market appreciation is very interesting.

There is the possibility that unexpected events may cause risk aversion to rise rather than abate. Uncertainty regarding European sovereign debt, the related fate of the euro, instability in the Middle East, the price of oil, government budget deficits in the United States, and fears of a hard landing in China have the potential to apply downward pressure to the equity markets. But we are inclined to be optimistic about the short- and long-term prospects for U.S. companies and equity markets. Our optimism is driven by the attractive company fundamentals, the relative value of equities compared to fixed income, and expansive monetary policy being employed in most parts of the world. Even with clearly present risks, equities appear to offer an attractive risk/reward profile.