Warren Buffett famously said that market downturns don’t bother him because “it is an opportunity to increase our ownership of great companies with great management at good prices.” That is how we’re approaching this market.
The speculation that drove stocks last year abruptly ended amid growing concerns of an economic slowdown spurred, in part, by uncertainties surrounding tariffs and fiscal policy. While we are not economists and don’t approach our jobs from a macro perspective, we observe a widening range of companies highlight softening consumer and business confidence resulting from tariff uncertainty. It’s reasonable to conclude that the longer this uncertainty persists, the more damage a potential pullback in consumer spending and business investment could do to the economy.
This concern pushed stock prices lower in the first three months of the year, with the S&P 500 Index falling briefly into correction territory (defined as a drop of 10% or more) between Feb. 19 and March 13. The S&P 500 finished the quarter down 4.3%. As is often the case in a fear-driven market, small stocks were hit harder, with the Russell 2000® Index slipping around 9.5%.
At the beginning of the year, we argued that the market was overlooking potential downside risks, as there are no guarantees the new administration’s efforts to boost GDP growth would succeed. Today, the opposite may be true. Investors are so consumed with the risk of a global trade war and stagflation; they seem to be overlooking potential opportunities that market volatility is exposing. The Investors Intelligence Sentiment Index, for instance, indicates a rapid shift in investor sentiment, with bullishness dropping swiftly from exuberance to pessimism on par with the 2008-09 global financial crisis, the 2015 industrial recession, the 2020 COVID-19 shutdowns, and the 2022 interest rate spike (see the chart below).

Source: Bloomberg. Daily data 3/30/2005 to 3/28/2025. This chart represents the recession periods comparing the Bloomberg Global High Yield and the Investors Intelligence Sentiment Data Percentage. The Bloomberg Global High Yield Index is a multi-currency flagship measure of the global high yield debt market. The index represents the union of the US High Yield, the Pan-European High Yield, and Emerging Markets (EM) Hard Currency High Yield Indices. The Investors Intelligence Index is a common and widely accepted means of ascertaining the balance of power between the bulls and bears. In actuality, the index may refer to one of several possible sentiment indicators, including an advisor sentiment review and an insider activity review. All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.
As more businesses are being priced for a meaningful economic slowdown, we are finding opportunities to increase our exposure to parts of the market that have been adversely affected by the shifting narrative. Guided by our 10 Principles of Value Investing™, we continue to focus on attractively priced, well-managed businesses that can grow intrinsic value throughout market cycles, while avoiding areas of the market at risk of permanent capital destruction. For instance, high-yield credit spreads, a measure of excess yield required by investors to own low quality debt, have only just begun to widen after hitting a cyclical low in late February (see the chart above) thus we still see plenty of downside in the equity of highly leveraged businesses.
Attribution Analysis
Our Strategy gained 0.90% (net of bundled fees) in the first quarter, trailing the performance of the Russell 3000® Value Index, which was up 1.64%. Stock selection was mixed in the quarter, with a positive selection effect in 5 of 11 sectors, led by Utilities and Information Technology.
There was a flight to safety at the start of the year, as the best-performing sectors in the Russell 3000® Value Index were defensive areas such as Energy and Utilities while cyclicals generally lagged. However, we outperformed the benchmark in several economically sensitive areas of the market including Information Technology, Financials, and Consumer Discretionary.
Large stocks in the benchmark outperformed by more than 800 basis points, another sign of risk aversion. This proved to be a headwind for our Strategy during the quarter, as large caps comprise just 28% of our exposure, with small and midcaps representing a combined 72%. We are confident, however, that the smaller companies we own are concentrated in undervalued businesses with strong long-term prospects.
Portfolio Activity
We construct our portfolio based on individual company fundamentals rather than sectors or market-cap preference. That said, we recognize that large caps typically outperform during periods of heightened volatility. With small-cap stocks generally pricing in slower economic growth more quickly, we increased our small-cap weighting by 400 basis points to 34%. Consistent with our investment philosophy, we prioritize companies with strong balance sheets and high returns on invested capital to mitigate downside risks.

Industrials. During the quarter, we initiated a new position in Donaldson Company, Inc. (DCI), a leading manufacturer of industrial filtration systems. Filtration is a “razor & razorblade” business model, with margins significantly lower on first-fit original equipment and higher on the annuity-like revenue stream from aftermarket sales. Thanks to Donaldson’s long history of operating in niche markets, its business skews around 65% aftermarket and 35% first fit, providing a more stable revenue profile than traditional Industrial machinery suppliers.
While DCI has historically traded at a premium to its Industrial machinery peers, because of its stable and more profitable revenues streams, the stock recently faced multiple compression due to margin headwinds created by the company’s investments in the life science industry. The life science portion of the business accounts for less than 10% of revenues yet Donaldson reported an operating loss in the segment due to new product development spend that is immediately expensed through the income statement.
We believe the investment headwinds are fully priced into the stock and expect life science filtration sales to be accretive to both revenue growth and margins in the longer term. Over the next two to three years, we expect the segment’s margins to approach the corporate average, which would translate to a 10-15% lift in total earnings power for the company.
Despite softness in the ISM Manufacturing Purchasing Managers Index since late 2022, DCI has historically outperformed when Industrial activity weakens due to the consumable nature of its products. Over the past two decades, the company has traded at a median 15% premium to the Industrial sector. Yet today, the stock is at nearly a 15% discount, based on its EV/EBITDA over the next 12 months.