As Moat Stocks Rebound, Inflation Looms

The Morningstar^® Wide Moat Focus Index^SM (the “Index”) finished an up-and-down January slightly negative for the month but ahead of S&P 500^® Index by more than 40 basis points (-0.58% vs. -1.01%, respectively). The tech, health care and energy sectors all contributed positively to Index returns, offsetting much of the negative returns from industrials, financials and consumer staples. In addition to January performance highlights, this month I’ll also touch on something that had been relegated to the backburner for quite some time but may now be coming to the forefront: inflation.

It’s all Relative for Moat Stocks to Start 2021

As speculation in a small number of stocks drove market headlines toward the end of the month, the Index quietly saw a reversal of the trends that led to 2020 underperformance. Several information technology companies in the Index posted encouraging returns in January, following a disappointing 2020, and others from vulnerable sectors also bounced back. Though negative as of the end of January, the Index is off to a good start relative to the S&P 500 Index.

Trailing Return (%) as of 1/31/2021

Periods greater than one year reflected annualized returns. Source: Morningstar. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. For fund performance current to the most recent month-end, visit vaneck.com.

Blackbaud, Inc. (BLKB) is a software company deeply entrenched in the nonprofit ecosystem, providing CRM, financial management and analytics solutions across the board. It benefits from high customer switching costs and, to a lesser extent, intangible assets, according to Morningstar. Blackbaud’s nonprofit customers are likely especially sensitive to budgetary issues and the potential costs of changing software make a switch less likely than in other industries. After beginning January trading at a nearly 18% discount to Morningstar’s fair value estimate, Blackbaud’s share price finished the month at less than a 5% discount.

Intel Corp. (INTC) is another tech company that struggled in 2020, particularly in the second half of the year, as it traded as low as 66% of its Morningstar fair value estimate. Its strong January combined with a fair value estimate decrease resulted in its discount to fair value narrowing considerably, but the company’s stock remained attractively priced. The driving force behind Intel’s impressive January was fourth quarter results that significantly exceeded expectations, according to Morningstar. Increased PC demand in the continued work- and learn-from-home environment due to COVID-19 helped support Intel’s fourth quarter results.

Consumer discretionary stock Polaris Inc. (PII) also experienced a strong bounce back following a trying 2020 when it faced demand concerns for its recreational vehicles through the pandemic-induced economic slowdown. Its fourth quarter financial results impressed the market, driving shares above fair value by the end of the month, even after Morningstar increased its fair value estimate to $113 per share from $100. The increase in fair value reflected Polaris’ robust fourth quarter 2020 performance and an adjustment to its 2021 outlook, which handily outpaced prior expectations, according to Morningstar.

What Drove Moat Index Returns?

Information technology companies contributed most significantly to the Index’ underperformance of the S&P 500 Index in 2020. The sector’s underweight paired with poor relative stock selection within the sector dragged on relative returns. Industrials stock selection was also a major contributor to underperformance while strong stock selection within consumer discretionary, energy and financials helped offset some of the Index’s short-term misses. 

Inflation Inflection and What It Means for Moat Stocks

As we look forward, inflation appears to be on the mind of many investors these days. It has been quite some time since we’ve experienced any serious level of inflation in the U.S., but more investors seem to be considering its potential impact on their portfolio. Historically, large cap U.S. stocks have weathered inflationary environments better than other asset classes, but not all companies are immune from rising costs.

Some areas of the equity markets stand to benefit from rising inflation, such as commodity-related materials and industrials companies and those involved in real estate. Other more defensive sectors, such as utilities with steady cash flows, are expected to be negatively impacted by inflation. Because the Index’s focus on valuations has shifted its sector exposure over time, predicting how it will be positioned when inflation takes center stage is hard.

More important to a broad-based core U.S. equity strategy may be the types of companies selected within sectors and industries. Focusing on those companies that have built sustainable competitive advantages may serve investors well if and when inflation does in fact rise. Many of these wide moat companies have pricing power that allow them to pass rising costs to consumers. In at least some way, all five sources of economic moat identified by Morningstar contribute to a company’s pricing power and expected ability to maintain profitability into the future.

VanEck Vectors Morningstar Wide ETF (MOAT) seeks to replicate as closely as possible, before fees and expenses the price and yield performance of the Morningstar Wide Moat Focus Index.