Time to be Active, Selective, and Disciplined

                        

In the third quarter, equity markets were highly volatile with a strong summer rally followed by a dramatic decline. On top of a continuing war in Ukraine, supply chain bottlenecks, and geo-political concerns, another major negative was the Federal Reserve’s more hawkish stance. 
 
The Federal Reserve set a record by increasing rates 75 basis points for the third time this year and telegraphed its intent to keep hiking aggressively to combat inflation — all in the face of a dramatic increase in rates, an inverted yield curve, and long-term mortgage rates doubling to over 6%. Economic activity has slowed, and investors seem to be concerned that further Federal Reserve increases will cause a deep recession.
 
Equity valuations have come down markedly with more speculative areas being crushed. As the playwright Arthur Miller noted, eras only come to an end when its myths are extinguished. Well, the speculative mindset, fueled by a decade of “easy money” that led equity investors to turn a blind eye toward valuations and leverage, appears to be over. As the chart below shows, the percentage of companies expected to see improving earnings over the next year is likely to be extremely low. In our view, this is an appropriate time to be an active, very selective investor.

In this environment, value stocks outperformed by 13 percentage points year to date — the Russell 3000 Value® Index is off 18% while the Russell 3000 Growth® Index is down 31%. However, the valuation disparity between value stocks and growth/momentum favorites has narrowed, and higher interest rates are likely to compress this further.

 

Despite these headwinds, after being out of favor for many years, value stocks should provide a rich universe for the enterprising investor. Heartland’s disciplined investment approach, focused on bottoms-up research, is well suited for today’s volatile investment climate. Our 10 Principles of Value Investing™ provide the structure to identify businesses with favorable risk vs reward characteristics. We believe patient investors will be rewarded for owning high quality assets with balance sheet strength and low price-to-earnings and continue to be optimistic on the long-term outlook for our Funds.
 
Thank you for your continued trust and confidence,
Your Heartland Team