Market Commentary as of 6/30/08
Mixed Market
Despite the weak US economy, oil prices rose 37% during the quarter to $140/barrel on long-term supply concerns and heightened tensions in the Middle East. Given the importance of oil to the economy, the price spike alone would be disruptive, but the ongoing housing contraction and credit crisis further exacerbated the pressure on consumer spending and businesses. Offsetting these factors were the generally healthy state of corporate America, the strength of international economies, and stimulus from the recent government tax rebates. Although the credit crisis eased a bit, it still limited leveraged buyouts. Merger and acquisition activity grew modestly, especially for cross-border transactions.
Overall, the Fund's Russell Midcap Value Index benchmark gained a meager 0.1% during the period, while its growth counterpart climbed 4.7%. The value index lagged primarily due to its much higher weighting in Financials, particularly banking and insurance stocks. These shares declined sharply due to worsening trends in credit and housing markets, in addition to the higher energy prices. Stock prices experienced their worst single month in six years during June, after respectable gains in April and May, as inflation concerns and a weak dollar prompted the Federal Reserve to hint at raising rates in the future. Performance was mixed across economic sectors, with strength in Energy and commodity stocks and weakness in Financials and consumer-related shares.
Winners and Losers
The Fund trailed its benchmark in posting a slightly negative return for the quarter. Stock selection in the Healthcare, Materials and Technology sectors hurt relative performance. Managed-care company Coventry Health Care slid as it lowered its earnings forecast for the upcoming quarter, and the year, on higher-than-expected cost trends. Specialty metals and materials firm Carpenter Technology declined as investors reduced exposure to commercial aerospace in light of higher oil prices. Within technology, the portfolio's holding in Progress Software fell as the company provided earnings guidance that was lower than expected for the next quarter, despite leaving its annual estimate essentially unchanged. Investment Technology Group detracted the most on an absolute return basis as lower market volatility reduced its trading commissions during the quarter.
An underweight stake in battered Financials—particularly banks, which declined 26%—and a higher weighting in the Healthcare sector as a whole relative to the benchmark aided performance. Stock selection within Financials also contributed meaningfully to the Fund's relative return as top-10 holding Willis Group announced that it was acquiring another of the portfolio's top-10 holdings, Hilb Rogal & Hobbs, at a 50% premium. In addition, oil and gas company Comstock Resources more than doubled in price following the surge in oil prices and the sale of Bois D’Arc, the company's offshore subsidiary.
Still Cautious
At Cardinal, we remain cautious about the prospects for the US economy for the balance of 2008 even as equity prices appear to be discounting a lot of negative news. Despite relatively low interest rates, we expect that economic growth will remain weak due to high oil prices, the continuing decline in housing prices, and dislocations within the credit markets. The pending Presidential election only adds to the uncertainty, as major changes in legislative priorities are inevitable. Nevertheless, we expect strategic buyers, particularly international ones, to increase acquisition activity during the second half of the year. Regardless, our goal is to continue to rely on the management teams of the companies in the portfolio to deliver solid financial results and enhance shareholder value over the long haul through intelligently reinvesting their free cash flow.
The Cardinal Capital Team
As of June 30, 2008, Coventry Health Care comprised 0.00% of the portfolio's assets, Carpenter Technology - 2.98%, Progress Software – 4.15%, Investment Technology Group – 2.50%, Willis Group -3.68%, Hilb Rogal & Hobbs – 2.85%, and Comstock Resources - 0.78%.
Note: Small and Mid-cap stocks are generally riskier than largecap stocks due to the greater volatility and less liquidity
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.