US stocks, as measured by the S&P 500, led global markets benefitting from a largely successful vaccination effort that enabled a quicker reopening of the economy and higher exposure to growth, which rallied alongside a flattening yield curve. Focusing on the performance drivers of the US market
specifically, large caps outperformed mid-caps which outperformed small caps while growth outperformed value in the large mid-cap universes; however, value prevailed versus growth in the small cap tier. Following what many viewed as a hawkish US Federal Reserve meeting in June, the rotation to mega-cap growth stocks intensified.
Sector leadership was a mix that reflected the crosscurrents mentioned above. Superior global economic and earnings revisions data coupled with the more hawkish views of future Fed policy resulted in a rotation from cyclical sectors, such as Financials and Industrials, to faster growing sectors, such as
Technology and Communication Services. The Energy sector unsurprisingly outperformed, benefiting from the strong performance of the underlying commodities mentioned above. Defensives, such as Utilities and Staples, which generally has outperformed in the late stages of the cycle, lagged significantly.
In Information Technology, the Fund continues to favor vertical software businesses, such as Adobe, Autodesk, and Cadence Design Systems, that have not traded at extreme price/sales multiples. The team prefers vertical software businesses over horizontal software due to the focused nature of improving and optimizing a product set for one specific industry versus trying to be all things to all people. As MFS analyzes growth, margin and multiple expectations for the software industry, the team’s view and conviction of the risk/reward opportunities has improved as other areas have rerated higher recently. The Fund aims to avoid extremely expensive names, notably on a price/sales basis, where the upper end of a wide range of outcomes is largely priced in, leaving little room for error on a valuation basis. Within IT services, the Fund continues to favor companies with exposure to digital payments, which has benefitted from the strong secular trend of cash to card conversion. Tailwinds in the space include continued penetration in e-commerce, low cost acceptance, mobile/contactless payments and financial inclusion, as well as the potential impact to longer-term behavioral changes, the result of COVID-19. Within the space, MFS continues to favor global payment service providers Visa and Mastercard, as well as PayPal and Square, which provide payment processing solutions and software.
The Fund’s overweight includes data providers such as Verisk, which provides data analytics for customers in insurance, energy markets and financial services; data analytics firm Clarivate; CoStar Group, which provides commercial real estate information and analytics; and credit reporting agencies TransUnion and Equifax. MFS tends to favor this area of the industrials sector given the capital-light nature of the business and the high barriers to entry provided by proprietary data. Top holdings in entertainment include gaming companies Electronic Arts, Activision Blizzard, Take-Two Interactive and ROBLOX.
Within Information Technology, the Fund remains underweight areas of the sector that require higher capital intensity and that have traditionally been more cyclically exposed to global growth. These areas include industries such as hardware and storage & peripherals, driven by our meaningful underweight to Apple. The Fund’s avoidance of Tesla drives its underweight in automobiles, while not owning big box retailers such as Home Depot and Lowes account for the majority of the Fund’s underweight in specialty retail.
The Fund’s long-term outlook for durable growth businesses that exhibit pricing power remains unchanged.
MFS looks at the US equity landscape from an industry perspective and seeks to identify companies growing at above market rates and where the profit pools are going and where they could go over the next decade. This provides a helpful sanity check on the outlook for growth stocks and helps MFS understand why certain growth-oriented companies, despite the near-term market rotation, have continued to take market share and why this trend will continue over the longer term.
Take the autos & housing industry and think about where future growth potential may come from. Here, one could argue any future growth may come from underpenetrated areas of the industry with large addressable markets such as electric vehicles and the Internet of Things (i.e. smart elevators, smart cars, connected homes, etc.). Even in traditionally lower growth areas like Consumer Staples, niche brands and healthy eating are long term trends which are enabled largely by the Internet and e-commerce as consumers have more choices available to them. MFS sees this trend in more traditional value sectors such as Energy and Financials, where they feel growth potential may go to solar or other alternative sources of Energy, and in Financials, where most of the growth has come from FinTech.
In Health Care, MFS feels potential growth may come from areas such as biotech, telehealth, next generation tools, and life sciences companies. In industrials, like autos & housing, it is all things digital, direct-to-consumer and the Internet of Things. Looking at leisure, expected growth potential may be in areas like streaming video-on-demand as well as video games. Finally, in retailing, it's all about e-commerce, digital or omni-channel or more direct to consumer businesses.
That said, there will always be points in time where companies, many of which lack real pricing power, will be aided by some external driver of earnings growth (i.e., higher GDP, higher rates, higher inflation, etc.). However, it is MFS’s belief that over time sustainable earnings growth will come from those companies that possess pricing power, the result of sustainable competitive advantages, high barriers to entry, intellectual property, and differentiated products and services, many of which reside in the growth universe.
Significant transactions over the period included:
- The Fund established a position in HVAC, fire and security equipment manufacturer Johnson Controls International, which focuses on improving building efficiency. The company compounds earnings and cash flows at an above market rate. MFS noted strong durable growth opportunities against a backdrop of aging buildings looking to upgrade systems to be more efficient and eco-friendly.
- The Fund added to its position in Icon PLC, a contract research organization that runs pharmaceutical trials on behalf of the biopharma industry. MFS believes health care R&D budgets will expand, and Icon is positioned well for industry growth while at the same time having an improved the quality of the business because of expanded customer diversification.
- The Fund added to its position in off-price retailer Ross Stores. MFS finds the off-price segment attractive and at less risk of being disintermediated by eCommerce due to the 'treasure hunt' nature of the shopping experience. MFS believes the company is positioned well for reopening and has a clear path for new store openings for the better part of the next decade.
- The Fund trimmed its position in SaaS provider ServiceNow, primarily due to a relatively full valuation. The company has significantly benefited from an accelerated demand for the digital transformation of businesses and the transfer of workflows to the cloud.
- The Fund exited its position in Alibaba. While still positioned well in e-commerce, margin dilution could occur with the company entering less attractive businesses including delivery, logistics and offline retail.
The portfolio is focused on companies that MFS believes can generate above-average, sustainable earnings growth over the next two to three years. The Fund’s strategy emphasizes companies that have the following characteristics: pricing power, strong secular growth, large potential opportunity sets, sustainable competitive advantages, superior business models and strong management teams. In addition to strong and sustainable growth, stock valuations are important when the Fund considers investments for the portfolio.
Significant impacts on performance