A Rare Opportunity?

“The stock market is a device to transfer money from the impatient to the patient.” 
—  Warren Buffett

The major indices spent much of the quarter buffeted by dramatic and frequent shifts in investor sentiment. The markets surged or retreated based on the latest trade war tweets and interpretation of economic data. Macro themes ruled for much of the period, and fundamentals of individual stocks were largely overlooked.
With no clear narrative in place for what the economy holds in the near term, investors sought to hedge their bets. In a quest for calm, they favored large companies over small and steadier−performers over their more−volatile peers. Valuation concerns were mostly overlooked and investors, as shown, continued to pay a premium for the largest publicly traded names.
Small−Cap to Large−Cap Historical P/E Ratio
Small-Cap to Large-Cap Historical P/E Ratio
Source: ©2019 The Leuthold Group, 1/31/1983 to 8/31/2019
The Leuthold Group created this chart using their proprietary Leuthold 3000 Universe. This universe is defined as the largest 3,000 securities traded on U.S. exchanges and was segregated into large− and small−cap tiers. Gray bars identify recessionary periods of July 1990 to March 1991, March 2001 to November 2001, and December 2007 to June 2009.
Price/Earnings Ratio (P/E): non−normalized trailing operating earnings.
Past performance does not guarantee future results.

As you can see, this is only the third time in the past 35 years that the gap in valuations between large and small stocks has reached a level this extreme. In the past, this disconnect has provided significant upside for those willing to stay the course with a disciplined fundamental approach. Following the other two periods—during the recession of 1990 and again when dotcom mania was at its peak—patient, small−cap investors in particular saw outsized returns in the months and years that followed.
Now, like then, we believe a contrarian streak, compelling valuations, and a laser focus on fundamentals are needed to capitalize on opportunities. The portfolios we manage, in our view, are filled with names that represent those three elements.

A Changing of the Guard?

We can’t predict the future, of course, but recent market activity has us cautiously optimistic that a change in market leadership may be on the horizon.  After watching investors for years gravitate toward large, sexy growth names or pay up in a quest for low volatility, we saw a sharp trend reversal in mid−September. Small−cap stocks started to outpace large companies, formerly hot initial public offerings softened, and investors finally seemed to be paying attention to valuations. 
If, as we hope, the growth−at−any−price delirium of the past decade is finally breaking, we believe the valuations and strong balance sheets held in your portfolio will go a long way in helping the type of patient investors Mr. Buffett references above capitalize on what we view as a third−in−a−lifetime opportunity.
Your Heartland Team


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Small-cap and large-cap investment strategies each have their own unique risks and potential for rewards and may not be suitable for all investors. Small-cap investment strategies emphasize the significant growth potential of small companies, however, small-cap securities, are generally more volatile and less liquid than those of larger companies. Large-cap investment strategies emphasize the stability of large companies, however, large-cap securities are more susceptible to momentum investments and may quickly become overpriced or suffer losses.