As a rule, investors seem to spend far too much time worrying about whether to be optimistic or pessimistic about the state of the markets or the health of the economy. As Ben Graham pointed out, the intelligent investor can make money in both buoyant and fraught markets, so long as they remain more disciplined than the investors from whom they are buying stocks and to whom they are selling.
We believe this is the right message for this market.
By most accounts, equities had a rough start to the year, as economic concerns that started to bubble up in the second half of 2021 rose to the surface in the first quarter, at around the same time the first land war in Europe since World War II broke out. This put the market in a decidedly defensive mood, which only intensified after the Federal Reserve delivered on its promise to start raising interest rates to try to get control over inflation. As the yield curve flattened in March, concerns emerged about economic growth in the months ahead.
A Renewed Focus on Valuations
Historically, when investors think growth is about to become scarce, they are often willing to pay a premium for growth stocks. Yet we’ve been encouraged with the market’s reaction so far this year.
Now that inflation and rates are on the rise, investors appear more mindful of downside risk and valuations, which serves to strengthen the tailwind that attractively priced, profitable, and well-managed companies began to enjoy late last year. In addition, as shown below, many smaller companies continue to trade at significant discounts to large-cap names, which we believe is a reason to favor small-cap names in this environment. These are shifts that we welcome.