Second Quarter Market Discussion
Recently, the shifting mood of the market has felt a little like bumper bowling, with investors’ views of the economy seeming to bounce in the opposite direction every quarter. As fears over a tariff-induced recession began to moderate, the Russell Midcap® Index advanced 8.53% in the quarter while the S&P 500 climbed 10.94%.
The notion that the market has written the final chapter on where the economy is headed may be wishful thinking. In our view, visibility surrounding the tariff and fiscal policy remains frustratingly unclear. The feedback we’re hearing from many senior managers is that they’re waiting for greater clarity before committing to long-term investments.
Complicating matters further, traditional economic indicators are sending those same decision makers mixed signals about which way the economy may be headed. Leading and coincident economic indicators have generally moved in sync, with the latter confirming the former over time. However, in recent years, leading indicators have been weakening. In fact, the gap between the two is currently the widest it’s been in recent history, reflecting the difficulties faced by both company executives and investors (see the chart below).
Source: FactSet Research Systems Inc., 1/31/1970 to 5/30/2025. This chart shows the Leading Economic Index versus Composite Index of 4 Coincident Indicators, and the spread between these two. The Composite Index of Leading Indicators, otherwise known as the Leading Economic Index (LEI), is an index published monthly by The Conference Board. It is used to predict the direction of global economic movements in future months. The Composite Index of Coincident Indicators is an index published by the Conference Board that provides a broad-based measurement of current economic conditions, helping economists, investors, and public policymakers to determine which phase of the business cycle the economy is currently experiencing. All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.
Besides company-specific forces, our relative performance has been influenced by several intertwined themes. In periods marked by compressed credit spreads and lower equity market volatility, growth strategies — and factors unrelated to valuation including momentum and earnings revisions — have routinely outperformed foundational valuation attributes like free cash flow yield. In the Russell Midcap Value universe, this dynamic was on full display, with historically extreme outperformance in the second quarter and for most of the time since the start of 2024. Over the long term, free cash flow-based valuation metrics have provided far more efficacy than momentum/revisions. Thematically, these dynamics were generally observed in companies somehow tied to cryptocurrency or artificial intelligence, amongst other examples. However, when risk aversion briefly returned to the market in February and March, these companies were among some of the hardest hit. At the same time, value outperformed growth and, for a brief-but-significant period, the free cash flow yield factor outperformed both momentum and revisions.
Our Strategy’s day-to-day relative performance is often inversely correlated with the growth-oriented factors and themes described above and positively correlated with the performance of attributes like free cash flow yield. We consider this evidence that our Strategy fits our piece of an asset allocation puzzle and sets the table for value-oriented stock-picking to assert its importance over time. We believe our approach to value, guided by our 10 Principles of Value Investing™ that focuses on attractively priced, financially sound businesses, is always important but could prove especially critical should any change to the running narrative occur.
Attribution Analysis
The Mid Cap Value Fund lost 0.22% in the second quarter, trailing the Russell Midcap® Value Index, which was up 5.35%. Stock selection was responsible for most of our underperformance.
As the environment shifted from ‘risk-off’ back to ‘risk-on’ during the quarter, the Strategy was hurt by not owning certain high-octane names in cyclical parts of the market such as Technology, Industrials, and Consumer Discretionary, which were the three best-performing sectors of the benchmark in the quarter. It should be noted, however, that in February and March we were rewarded for not owning many of these companies when the rising tide ceased. During that brief pocket of volatility, we were able to buy shares of attractively priced companies that we believe will serve the portfolio well in the coming years.
In addition to our 10 Principles of Value Investing™, our Strategy is built around our “two-bucket” approach to portfolio construction. At all times, we hold both high quality mid cap companies trading at bargains (“Quality Value”) and deeply discounted businesses that have produced poor economic returns over time (“Deep Value”) but that have a self-help catalyst to unlock value. We do this because within value, each of these styles tend to take turns outperforming, just as periods of growth and value outperformance tend to alternate over time.
During the quarter, our stock selection in both buckets reversed versus Q1 and lagged in a sharply rising market. As risk aversion disappeared, a significant portion of the quarter’s underperformance was related to not owning many of the “higher octane” leaders in the Index because they do not fit our investment process in key areas related to valuation, financial soundness or business model attributes. That said, in a backdrop that didn’t favor traditional value companies to begin with, we had a few earnings updates that tested investors’ tolerance. In these cases, we believe patience is warranted, including in the Becton-Dickinson example below.
Portfolio Activity
Financials. During the quarter, we initiated a position in Everest Group LTD (EG), a Deep Value global insurer with a long history of operating in the property natural catastrophe (NatCat) reinsurance market. Property & casualty underwriters such as Allstate, Progressive, and GEICO purchase NatCat reinsurance to protect their balance sheets against major weather events including hurricanes and earthquakes.
NatCat reinsurance is a commodity business where supply and demand dictate terms. When times are good, capacity enters the market, diminishing returns through competition. As a result, the return on equity (ROE) for the industry tends to be more volatile than for primary underwriters.
In Everest’s case, prior management made some poor underwriting decisions, pushing a diversification strategy that expanded the company’s exposure to the U.S. casualty market, which protects individuals and businesses from financial obligations resulting from bodily injury or death in the event of an accident. Unfortunately, U.S. casualty losses have risen meaningfully over the past decade due to an aggressive plaintiff bar and “nuclear settlements” awarded to claimants.
The company’s new CEO has been aggressively repricing this risk. When insurance companies write less risk, capital can be freed up for other purposes, such as buying back shares. In essence, new management has adopted a shrink-to-grow strategy.
Meanwhile, the stock carries a heavily discounted valuation, trading at just 1x tangible book value, versus Everest’s 25-year average of around 1.15x tangible book value. Relative to its industry peers, the stock looks even cheaper, trading at a 40-50% discount to specialty P&C insurers and a 25-50% discount to property natural catastrophe insurers.
Industrials. A new Quality Value position initiated during the quarter was Hubbell Inc (HUBB), a leading electrical component manufacturer. Over the past decade, Hubbell implemented self-help actions to shift its portfolio away from traditional commercial construction end markets and toward the power grid/utility end market, which now represents more than two-thirds of sales, thereby reducing exposure to construction spending cycles. At the same time, Hubbell has simplified its product offerings and consolidated 15% of its footprint, rationalizing underutilized assets and creating flexible capacity for faster-growing markets.
During the pandemic-related supply chain disruptions, many of Hubbell’s utility customers over-ordered products to ensure availability in the field. By 2024, as lead times normalized, destocking efforts accelerated and organic revenue turned negative. The stock came under further pressure in early 2025, as investor sentiment toward power generation demand took a hit.
As a result, the stock is now attractively priced in our opinion. After trading at a median 15% premium to its peers over the past 5 years and a 5% premium over the past decade, HUBB fell to a 10% discount in April and is now roughly in line with other Industrial companies on an EV/EBITDA basis. We also expect the company to benefit from continued demand for transmission and distribution infrastructure owing to the country’s aged electrical grid, and Q1-25 earnings confirmed our view that customer destocking has generally ceased.
Health Care. Our Strategy’s worst performer was Becton, Dickinson and Company (BDX), the world’s largest provider of healthcare consumable products such as needles, syringes and medication management systems.
Since the end of April, BDX shares have fallen nearly 20% after the company lowered its 2025 guidance to reflect the impact of the National Institute of Health funding cuts and an expected $0.25 EPS hit from tariffs. Even if growth fails to accelerate from the low single-digit rate implied for this year, we consider the multiple compression overblown for a business that has little or no risk of facing an earnings cliff.
We think investors are underestimating the durability of BDX’s mission-critical position in healthcare settings and its ability to adapt. The company has a strong track record of navigating fluid circumstances, being among the first in its industry to surpass its pre-COVID-19 margins following the global pandemic. We believe BDX can reaccelerate organic growth and drive further margin expansion, despite being priced for neither to occur.
The company has also reshaped its pipeline to target higher-growth markets that should align it more closely with bellwether med-tech stocks that command premium multiples. At 12x earnings, there’s nothing premium about BDX’s current valuation. The stock currently trades at 15% discount to the Russell Midcap® Index based on Enterprise Value/EBITDA. For most of the past decade, BDX carried a premium relative multiple ranging from 10-60% compared to the same Index.
Outlook
As consensus views on the economy keep changing and the market shifts from ‘risk on’ to risk off, we believe it is prudent to maintain a balanced strategy. That’s how we approach the mid-cap value universe — by aiming for a constant mix of high-quality companies trading at bargain prices and deeply discounted businesses with identified self-improvement catalysts. Our approach to value investing won’t always lead the market quarter to quarter, but we believe that fundamental factors such as strong free cash flow and attractive valuations are always valuable over time, especially when speculation exceeds risk aversion. In the meantime, our approach will remain consistent and disciplined.