The pessimism of 2022 continued into the third quarter, as the majority of major indexes again posted negative results for the quarter. War in Europe, runaway inflation, rising interest rates and expectations of a collapse in corporate profits weighed on capital asset prices.
The Federal Reserve is raising interest rates at the fastest pace in four decades, in an attempt to control the highest inflation that we have seen during those 40 years. The most recent Fed policy meeting resulted in a 0.75% interest rate rise, its third in a row. While the rise was forecasted, the central bank offered a surprise: new projections revealed that rates will likely rise to more than 4.5-4.75% at the end of 2023, exceeding market expectations.
Meanwhile, the unemployment rate increased slightly to 3.7%; however, it remains historically low and there is still a shortage of workers. The demand for labor, coupled with rising prices continues, to lead to wage pressure. From September 2021 to September 2022, the Consumer Price Index (CPI) increased by 8.2%.
The Snow Small Cap Value strategy outperformed the benchmark by 239 basis points during the quarter, returning -2.22% gross of fees (-2.33% net of fees) while the Russell 2000 Value index declined -4.61%. The strategy is outperforming the Russell 2000 Value by 279 basis points through the first three quarters of 2022.
The Small Cap Value portfolio outpaced its benchmark for the quarter largely due strong stock selection but was also aided by sector positioning. Stock selection was notably strong in the Consumer Discretionary, Financials and Materials sectors. However, selection within Health Care was the largest detractor from relative performance. The portfolio benefited from its underweight allocations to Real Estate and Utilities and an overweight position to Energy.
Top 5 Performance Contributors
|Stock||Avg Weight %||Contribution %|
|Super Micro Computer||4.65||1.44|
|Old National Bancorp||3.35||0.35|
SMCI rose during the quarter as the company reported a significant increase in revenue and net income more than doubled from the previous quarter. Further, investors reacted positively after the Chairman and CEO, Charles Liang, commented on the company’s growth trajectory. Given SMCI’s strong balance sheet and favorable valuation, approximately 8x forward earnings estimates, we anticipate further share price appreciation.
HF Sinclair (DINO)
DINO increased during the quarter as the company posted signs of improving execution at its key refineries. Supported by the rise in margins for refined products, DINO generated significant cash flow and began executing on a large share repurchase. With demand for gasoline and jet fuel returning to normalized levels, as well as a reduction in global supply capacity, the outlook for refining margins remains healthy.
Modine Manufacturing (MOD)
MOD saw a sharp rise in the stock price after reporting quarterly earnings in early August. The quarter’s results showed a beat on earnings, strong demand in key end markets and emphasized MOD’s ability to raise prices sufficiently to offset inflationary pressures.
Top 5 Performance Detractors
|Stock||Avg Weight %||Contribution %|
|Lions Gate Entertainment||4.33||-0.95|
|Silicon Motion Technologies||2.54||-0.57|
PLAB, a manufacturer of high precision quartz plates that are used to transfer circuit patterns onto semiconductor wafers, lost value during the quarter. The shares pulled back from a multi-year high after management cautioned on pushouts of orders from certain customers. Investors showed caution with the name given the backlog visibility for the company is just 3-4 weeks and the company only gives guidance one quarter at a time. We believe that given capacity constraints, utilization should remain quite high even if overall demand pulls back as expected.
Lions Gate Entertainment (LGF/A)
LGF detracted from relative results as the company’s self-imposed deadline of the third quarter, in seeking potential strategic alternatives for their STARZ business, came and went without an announcement. Management did announce that splitting up the business to unlock value remained their primary objective; however, it may be the Studio business and its associated content library with $750m in trailing-twelve-month revenue, at a nearly 50% cash margin that ends up being the focus of a potential transaction.
ACCO Brands (ACCO)
ACCO lost value during the quarter as it experienced currency headwinds from their EMEA exposure, and separately reset growth expectations for the year in its gaming peripheral business. ACCO trades at a 30% FCF yield and is poised for a strong back-to-school season and a seasonal influx of free cash flow.
*as of September 30, 2022
|QTD||1 Yr||3 Yr||5 Yr||7 Yr||10 Yr||Since Inception* *|
|Russell 2000 Value||-4.61%||-17.69%||4.72%||2.87%||7.41%||7.94%||5.39%|
Calendar Year Performance
|Russell 2000 Value||-21.12%||28.27%||4.63%||22.39%||-12.86%||7.84%||31.74%||-7.47%||4.22%||34.52%|
Source: SEI Global Services
* Returns for periods greater than a year are annualized. Past performance is not indicative of future results.
* * Inception: 10/31/06
Top 10 Holdings
|Delek US Holdings||5.07%|
|American Equity Investments||4.87%|
|Super Micro Computer||4.54%|
|CNO Financial Group||4.03%|
Total Effect Attribution vs Russell 2000 Value
The central bank’s tightening cycle has been a tailwind to value investing. While investment style trends oscillate over time, there have been extended stretches where the market rewards either growth or value, only to be followed by a reversal and subsequent outperformance by the opposite style. For the year-to-date period, value stocks have outperformed growth stocks. In our view, we are in the early stages of a cycle rotation where investors will continue to reward value over growth. After over a decade of growth outperforming value, the valuation spread between the two styles continues to remain wide. We expect inflation to pull back from the past year’s high, but we anticipate it to remain above its long-term average.
Higher average accelerations in underlying prices often coincide with investors rewarding value stocks. Low price-to-earnings companies produce cash flows that track inflation and the revenue streams of these assets are typically tied to higher prices as well. Meanwhile, the spike in interest rates will likely degrade the forward price-to-earnings multiples of some corners of the market, particularly higher growth stocks. This will relatively hamper growth, more than value, turning investors towards favoring stocks with strong fundamentals.
Even in the face of uncertainty and the potential risk of recession, our longer-term outlook for the U.S. economy and the stock market remains unequivocally bullish. Looking into the upcoming quarters, the key variables for investors will be the magnitude and duration of a likely recession. Further, the direction of equity prices will respond to GDP gauges, inflation reports and the Central Banks’ response to it.
All told, we continue to hold companies with compelling business fundamentals, skilled management teams, reoccurring cash flows, and the flexibility to adapt to an inflationary environment. We believe these stocks will compound earnings over an extended period through both rising and declining markets. Our portfolio of stocks is significantly discounted based on relative multiple valuations, compared to its benchmark. We remain dedicated to delivering strong long-term performance and transparent communications to our investors. As always, we welcome your comments and questions. Thank you for your commitment to Easterly Investment Partners.
Easterly Investment Partners (EIP) is a registered investment adviser. Registration of an Investment Advisor does not imply any level of skill or training. This composite has been assigned to Easterly Investment Partners (EIP) effective July 1, 2021. Performance presented prior to July 1, 2021, occurred while the Portfolio Manager(s) and the research team were affiliated with a prior firm (Snow Capital Management, L.P.). EIP claims compliance with the Global Investment Performance Standards (GIPS®). A fully compliant GIPS presentation along with a complete list and description of all composites is available upon request. The Small Cap composite include fully discretionary small cap value equity commission accounts. Prior to 10/01/13, the Small Cap composite required fully discretionary accounts contain at least a 75% small cap investment allocation for inclusion in the composite.
This composite dates back to October 31, 2006. This composite has no minimum requirement and for comparison purposes is measured against the Russell 2000 Value. The U.S. Dollar is the currency used to express performance. Leverage is not used in this composite. Investing involves risk; clients may experience a profit or a loss. In addition to the normal risks associated with investing, investments in smaller companies typically exhibit higher volatility. Past performance is not indicative of future results. Performance is preliminary. Composite returns are shown gross of fees and do not reflect the deduction of advisory fees. Actual returns are shown gross of fees and do not reflect the deduction of advisory fees. Actual returns will be reduced by advisory fees and other expenses incurred in the management of the account. EIP’s advisory fees are outlined in our Form ADV Part 2A (Brochure), which is available upon request.
The effect of an advisory fee compounded over a period of years, on the total value of a client’s portfolio is represented by the following example. Assuming an initial portfolio of $1 million earning a 10% return each year which incurs an annual advisory fee of 1.0% payable quarterly in advance, the portfolio would be worth $1.53 million net of fees and $1.61 million gross of fees after 5 years, $2.37 million net of fees and $2.59 million gross of fees after 10 years and $3.58 million net of fees and $4.15 million gross of fees after 15 years. Past performance is not guarantee of future results. The performance of any individual portfolio may vary from the Composite’s performance.
The views expressed herein are solely the opinions of EIP. We make no representations as to their accuracy. This communication is intended for informational purposes only and does not constitute a solicitation to invest money nor a recommendation to buy or sell certain securities.
The performance figures are based on a composite of many accounts and not all accounts owned the securities mentioned in this commentary. Holdings and sector allocations are subject to change. The latest copy of our Form ADV Part 2A (Brochure) and a complete list and description of EIP’s composites and/or a presentation that adheres to the Global Investment Performance Standards (GIPS®) is available upon request.
Russell 2000® Value Index
The Russell 2000 Value Index measures the performance of small-cap value segment of the U.S. equity universe. It includes those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. Indexes are unmanaged. It is not possible to invest directly in an index.