Small and Mid Cap Investing in Volatile Markets


Finally I want to touch on macro valuations. Our preferred method of valuing the stock market is looking at implied equity risk premiums, or how much investors demand inequities relative to bonds. The higher they demand, the cheaper stocks are. And one simple way to look at this is to look at the earnings yield on stocks as compared to the yield on Treasury bonds. And historically, stocks have yielded, depending on what time period you're looking at, 100, 200 basis points more than bonds. Currently, if you look on a trailing basis, stocks are yielding 550 basis points more than bonds, so much more than double the average over time. And pretty close to where we were in the Global Financial Crisis, which touched a little over 600 basis points. So relative to bonds, we think stocks are fairly attractive though we acknowledged that earnings will take a big hit here and take a little while to come back. But nevertheless we view stocks as pretty attractive relative to bonds. And particularly within stocks, we, of course, favor growth equities. Our confidence is pretty strong and its driven by five points. Number one, growth equities are much less cyclical in our view than value stocks. We've gone back to the past two recessions and shown that growth companies tend to be able to keep their earnings flat or even grow them modestly, while value companies have seen earnings decline on average about 40%. Secondly, growth stocks have more exposure to the digital or virtual economy, whereas value stocks have a little more exposure to physical or tangible goods, like autos and equipment which is more impacted by the border closings and the lack of free flow of goods across the world. Thirdly, value stocks are more adversely impacted by the low interest rates that you see in this crisis and in most economic crises as bonds go up and interest rates go down. That hurts the large financial weighting in value stocks. Whereas you could argue that growth stocks, and in particular the small growth stocks that Weatherbie is going to talk about, are longer duration assets and may even be helped by lower interest rates. Fourth, growth stocks generally have better balance sheets than value stocks. We think strong balance sheets are really important to help weather the storm and emerge on the other side of the crisis and thrive and take share.

And growth stocks are generally much more innovative, which we've written a lot about. And you can read more about on the website under Insights. And lastly, I want to mention we think it's a pretty great time for skilled active managers because the correlations between stocks within the S&P 500 are the highest that we've seen on record and our data goes back to 1995. So, it's possible that some very high quality companies have gone down, alongside with some lower quality companies and that might be producing a very good opportunity set for skilled, active managers. Alright, let's move into the Q&A portion with the Weatherbie team. Matt, let me start with you. You've been a portfolio manager for a long time and during your career you've been through many financial and economic crises. Can you help us understand how you're feeling about this portfolio in light of the current crisis? Matt Weatherbie : Brad, we've seen the VIX exceed 40, a historically high number for a number of days in a row now. And most recently it's been over 50. So, fear is rampant. I have seen these market crises before, including 1987, 1998, 2000 to 2002, which included 9/11, 2008, 2009 and most recently, the fourth quarter of 2018. That experience can help us to put things in perspective. In the current pullback, first we saw a lot of what we consider to be low quality companies decline. Next, the best higher quality companies, the ones we seek to invest in, are also being thrown overboard. We believe that Weatherbie 50 – our portfolio, are still excellent businesses. Evidence from some economists suggest that we may now have entered a recession due to COVID-19. A great majority of stocks have fallen sharply in this waterfall market decline. We believe that when they bottom out, the highest quality companies should recover the first and strongest, just like 1987, 2009 and 2018, which this downturn reminds me of. We believe the Alger Weatherbie Specialized Growth strategy is a portfolio of such companies. Brad Neuman : Great. Thank you. Can you also maybe discuss the portfolio positioning and any subtle shifts you've made recently?

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