Market Commentary as of 6/30/08
The second quarter saw a nice rebound in stocks only for the rally to give up ground the last two weeks of the quarter as the Dow Jones Industrial Average hit new lows and the S&P 500 Index was knocking at the door to new lows. Interestingly, broader indices such as the Wilshire 5000 Index and those from Russell remained well above their lows, and the Fund is down half of what it was at the low of the year.
The Japanese Yen trades at 106 to the dollar, up from 98 at its low. The Euro trades at 158, not 160, and two-year Treasury yields are at 2.6%, not 1.4%. Thus, despite the stock of General Motors selling at 1955 levels, consumer sentiment at 18-year lows, the market having its worst June since the 1930s, and that there was not one venture capital sponsored initial public offering during a quarter for the first time in thirty years, there were some bright spots. The Purchasing Manager Index for June was north of 50 and up from May's level of 49.6, thus still not corroborating an economic contraction—at least not yet.
The bottom line is that oil is holding this market hostage, and oil is under the sway of currencies—specifically the strength of the Euro driven by the European Central Bank's (ECB) earlier anti-inflation rhetoric. Given the dramatic softness in the economic numbers coming out of Europe, we would expect the ECB to continue to tone down their hawkish view after its recent 25 basis point increase, allowing the dollar to potentially rally below 155 against the Euro and spark a healthy correction in oil.
Why are we, as small-cap growth managers, focused on these macro subjects? This is the environment we are in. Fundamentals have taken a back seat to bank write-downs and oil. During the second quarter, earnings on holdings in the portfolio came in 8% above expectations, and we saw some increases to Wall Street's earnings estimates--though nothing like we would have seen in a more positive environment. Collectively, we have been in the business for 52 years and the last time we saw sentiment this bad was during 1981-1982. Combine that with the current credit crisis and you can throw in the 1990-1991 period on top of that as well.
For the Fund, Technology and Industrials—the latter still the portfolio's largest position at 32% of assets and biggest overweight relative to its Russell 2000 Growth Index benchmark—bounced back nicely during the quarter. One might remember that these two sectors were the Fund's two worst performing groups during the first quarter of 2008 as the market succumbed to the foregone conclusion that we were in a prolonged economic downturn. Energy, which now comprises 17% of assets and consists of mainly domestic natural gas plays where production is growing, gained 30% in also adding positively to returns. Healthcare was unchanged, while Materials and Consumer Discretionary were the two sectors that were down in the quarter and negatively affected performance.
While we would have rather closed the quarter in the middle of June, this is what building a major bottom is all about. Typically, our strategy drops prior to major moves to the downside in the overall market, and holding up well after large sell-offs usually portends a bottoming process. Since the market bottom on March 10, 2008, the Fund has significantly outperformed both its benchmark and the broader Russell 2000 Index through the end of the second quarter. Currently, our proprietary earnings estimates for the Fund's holdings are 29% greater than Street consensus estimates, a level we've never seen before. We believe that disparity reflects the current severe drop in market sentiment—which we believe can be a good thing for active managers, such as ourselves, willing to stick to their process.
B. Anthony Weber and Charles P. McCurdy, CFA
Note: Small company stocks may be subject to a higher degree of market risk than the securities of more established companies because they tend to be more volatile and less liquid.
The views expressed above are for informational purposes only and is not intended as investment advice. Since the date of the commentary, economic, market conditions and the portfolio manager's views may have changed. Holdings and weightings are subject to change daily. Holdings are provided for informational purposes only and should not be construed as a recommendation to buy or sell the securities mentioned.
Past performance does not guarantee future results. Investment return and principal value of mutual funds will vary with market conditions, so that shares, when redeemed, may be worth more or less than their original cost.