Q1 2024 Market Overview
Global financial markets rallied in the first quarter of 2024, led by large-cap technology stocks. This rally was fueled by strong economic data and continued momentum trading in stocks related to artificial intelligence (AI). Despite hawkish commentary from the Federal Open Market Committee (FOMC) on higher interest rates, optimism remained high in the markets.
While interest rates increased, expectations for a recession receded. Large-cap stocks outperformed small-cap stocks, with the NASDAQ continuing to rally even in the face of rising interest rates. This outperformance was concentrated in a few dominant companies, including Amazon, Microsoft, Meta, and Nvidia.
Sector Performance
Within the Russell 2000 Value (R2000V) index, cyclical sectors such as Energy, Industrials, and Materials paced the advance. Healthcare also posted solid returns, while Communication Services, Financials, Consumer Staples, Real Estate, and Utilities lagged.
Valuations and Outlook
Despite higher growth expectations for small-cap companies compared to large-cap companies, the valuation gap between the two remained wide, with small-cap valuations remaining very attractive relative to large-cap valuations. This gap is considered unsustainable and is expected to narrow over time as stubbornly high inflation cools and interest rates normalize while the economy continues to grow, albeit at a more moderate pace.
The broadening out of the market is also seen as a positive sign for small-cap stocks, as the momentum trade within a high concentration of mega-cap stocks begins to fade. This sets up a constructive backdrop for owning small-cap stocks.
Portfolio Performance
The Bernzott US Small Cap Value strategy gained 8.5% net of fees in the first quarter of 2024, outperforming both the Russell 2000 Value (2.9%) and Russell 2500 Value (6.1%) indices. Energy holdings were the leading contributors to the portfolio’s returns, with strong stock selection driving the outperformance. Within Financials, HCI Group was a top contributor, benefiting from positive quarterly results and the ability to assume additional in-force premiums.
Consumer Staples also performed well during the quarter, with Lancaster Colony benefiting from strong quarterly results and easing food commodity prices. Materials were the leading detractors to performance, with MP Materials declining due to weakness in NdPr prices.
Portfolio Activity
During the first quarter, the portfolio added PotlatchDeltic Corp. (PCH), a vertically integrated timber REIT, to its holdings. The company is positioned to benefit from an improving housing environment and an undersupplied timber market.
Two investments, Evercore (EVR) and Gentex (GNTX), were sold after reaching their fair value targets, generating sizable gains for the portfolio.
Investment Philosophy
Bernzott Capital Advisors employs a bottom-up, fundamental value investment approach. The firm seeks high-quality companies with market leadership, recurring revenue, high margins, strong returns on capital, financial flexibility, and strong management teams. These characteristics are believed to drive long-term compounding returns and resilience in downturns.
