All Cap Value – Q4 2022 Commentary

After lying dormant for decades, the resurrection of high inflation during 2022 was a shock to nearly all markets from equities to bonds to cryptocurrencies to even cash. The S&P® 500, Nasdaq Composite and Russel 2000® declined 18.1%, 33.1% and 20.4%, respectively, for the year. Bonds were hit by higher interest rates as the yield on the 10-year US Treasury Note increased from 1.496% to 3.826% which hit the Bloomberg Aggregate Bond Index by 12.9%. Cryptocurrency Bitcoin, declined by more than 60%. The purchasing power of cash also declined as inflation increased by 6.5% in 2022 after increasing 7% in 2021. Some of the only areas of strength came from energy with the PHLX Oil Service Index +59.1% and the Dow Jones Commodity Index +10.83% up for 2022. (Otani, WSJ)

Inflation’s surge emerged from several different sources resulting in both cost-push and demand-pull inflation. The cost-push inflation continues to be created by a tight US labor market which is driving double-digit increases in wage inflation for some market sectors which are struggling to find people to meet customer demand. The unemployment rate finished 2022 close to a record low of 3.5%. In addition, COVID-19-related shutdowns in China and limits on supply from underinvestment in energy and industrial commodities along with lingering supply constraints from the Russian/Ukraine war have all curtailed the aggregate global supply of energy, industrial/food commodities, and supply of goods, in general, across many sectors and regions. Finally, tariffs and reshoring of production have reversed the multi-year deflationary impact of outsourcing production to lower-cost regions which may create more expensive domestically-produced goods moving forward. The demand-pull inflation came from excessive fiscal policy as governments tried to deal with COVID-19, environmental change, and improvements to US infrastructure/reshoring. The Federal Government spent around $6.7 trillion from 2020 through 2022 on economic stimulus including $3.1 trillion from the Trump Administration ($2.2t CARES Act 3/27/2020, $900b COVID-19 Relief Bill 12/27/2020) and $3.7 trillion from the Biden Administration ($1.9t COVID-19 Relief 3/11/21, $1.2t Infrastructure 12/15/21 and $500b Inflation Reduction Act/Chips Act 8/16/22). The amount of federal stimulus since 2022 of around $6.7 trillion exceeded the total spending of $4.7 trillion spent during World War 2 with the stimulus continuing to flow into the overstimulated economy. (Harrington, Swenson USA Today)

Throughout 2022, the Federal Reserve started to aggressively deal with the higher inflation through an unprecedented increase in the Federal Funds Rate which increased by a cumulative 4.25% during the year from 0.25% at the start of the year to 4.5% by the end of the year. Most of the increases occurred between June and November with the Federal Reserve increasing rates by 0.75% at 4 consecutive meetings. This rapid tightening so far has yet to be fully realized in the economy but is expected to slow aggregate demand and cool the inflation surge. Even with the unprecedented tightening, the Federal Reserve remains vigilant and is expected to raise the Federal Funds Rate to at least 5.1% by June of 2024 to combat the inflation problem. 

The Federal Reserve was slow to act at first, but has become much more aggressive in combating the inflation surge with the goal of reducing inflation to a target of 2% from 6.5% in 2022. The Federal Reserve is trying to emulate the inflation hawk and Federal Reserve Chairman, Paul Volcker who aggressively attacked inflation at the end of the 1970s by raising the Federal Funds Rate from 6.5% to 18% over a 3-year period. This sent the US economy into a couple of severe recessions in the early 1980s, but set up several decades of subdued inflation and strong Federal Reserve credibility as an inflation fighter. Today’s Federal Reserve seems to be just as serious about combating inflation and should be rewarded with less long-term inflation.

For 2022, All Cap Value declined 5.25% (net of fees) vs. the Russell 3000® Value Index falling 7.98% Positive stock selection and asset allocation has helped drive the positive relative performance for the year with good contribution from Consumer Staples, Health Care and Energy more than offsetting weakness from Consumer Discretionary, Information Technology and Utilities.  Please see additional performance information in the table below.

Data as of 12/31/22                       

Even with the recent turmoil from inflation and subsequent decline in equity values, our investment approach, which focuses on a bottom-up approach focused on improvement in returns on invested capital, continues to uncover good companies at reasonable valuations.  

As always, we want to thank you for the confidence you have placed in Kennedy Capital, and we appreciate the opportunity to manage your account.  

Sincerely,

Chief Investment Officer & Portfolio Manager

Assistant Portfolio Manager

Important Disclosures

Kennedy Capital Management LLC (“KCM”) is a Delaware limited liability company headquartered in Missouri.  KCM is registered as an investment adviser with the Securities and Exchange Commission under the Investment Advisers Act of 1940. Registration with the SEC does not imply any level of skill or training. Clients of the Firm include U.S. corporations, pension and profit sharing funds, colleges and universities, trusts, not-for-profit organizations, foundations, and individuals. KCM claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. GIPS® are a set of standardized, industry-wide ethical principles that provide investment firms with guidance on calculating and reporting their investment results to prospective clients to ensure fair representation and full disclosure of an investment firm’s performance history.

 Although the statements of fact and data in this report have been obtained from, and are based upon, sources that the Firm believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitute the Firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. A complete list of all securities recommended by KCM in the preceding year, a fully compliant GIPS composite report, and the list of composite descriptions are available upon request from KCM at 10829 Olive Blvd., Suite 100. St. Louis, MO, 63141.

The All Cap Value Composite invest primarily in value securities of companies without a market capitalization constraint. The Manager generally looks for undervalued companies generating cash flow returns on invested capital greater than industry peers. All Cap Value portfolios generally demonstrate valuations below and growth characteristics at or above those of the benchmark. The weighted average market capitalization of the Account will generally be reflective of the Russell 3000® Value Index. The U.S. Dollar is the currency used to express performance.

Composite specific data provided within this presentation has been calculated from accounts that are discretionary as defined in this paragraph. The assets shown are derived only from discretionary accounts. Non-discretionary accounts, as defined by KCM, are accounts that are not included in the composite due to one or any combination of the following criteria: there were significant cash inflows or outflows within the account; the account’s asset level did not meet the minimum requirement to remain in the composite; the account assets are managed by others using our non-discretionary model. The temporary removal of such an account occurs at the beginning of the month and the account re-enters the composite the month after the criteria has been met.

Performance returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Gross of fee returns reflect the deduction of transaction costs and custodian fees but do not reflect the deduction of investment advisory fees. Net of fee performance is calculated using gross returns less the actual applicable annual management fee applied monthly. Past performance is not indicative of future results. A client’s return will be reduced by the advisory fees as described in Form ADV Part 2A and other expenses incurred by the account. For example, an annual advisory fee of 1% compounded quarterly over 10 years will reduce a gross 14.44% annual return to a net 13.32% annual return. Form ADV Part 2A is available upon request.

The performance figures reported herein are unaudited, may be based upon information obtained via electronic data sources (”feeds”) and may be subject to change. Data feeds from many of KCM clients’ selected custodians are obtained through third party sources, and are used to compare custodial data to KCM’s client account records as frequently as daily. Monthly, KCM reviews clients’ account holdings along with cash and share quantities against the custodial statements. In some instances, variances may exist between final audited custodial information and the information KCM obtains via such data feeds. Generally, any such variances are researched and reconciled within thirty days of the period end.

The information provided should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in a KCM portfolio at the time you receive this letter or that securities sold have not been repurchased. Allocations among industries, sectors and securities may vary and are subject to change without notice. Any securities discussed do not represent an account’s entire portfolio and, in the aggregate, may represent only a small percentage of an account’s portfolio holdings. It should not be assumed that any of the industry or sector allocation decisions mentioned, or securities transactions or holdings discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.

Sector Weightings are subject to change at any time.  Sectors are based on the Global Industry Classification Standard (“GICS”) classification scheme and are measured as a percentage of the total composite in terms of asset value as of the date indicated above.  Individual client portfolios may be different based on variations in security purchase price and date, and individual client restrictions. 

GICS was developed by and is the exclusive property and a service mark of Morgan Stanley Capital International, Inc. (”MSCI”) and Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. (”S&P”) and is licensed for the use by KCM. Neither MSCI, S&P, nor any other party involved in making or compiling the GICS or any GICS classifications makes any express or implied warranties or representations with respect to such standard or classification (or the results thereof),and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability, and fitness for a particular purpose with respect to any of such standard or classification. Without limiting any of the foregoing, in no event shall MSCI, S&P, any of their affiliates or any third party involved in making or compiling the GICS or any GICS classifications have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages.

Allocations to various assets classes change over time and deviate from any stated or targeted percentages of a total portfolio as a result of market conditions and reallocation decisions. Therefore, nothing herein reflects a static portfolio allocation that will remain the same or match stated target allocations of asset classes.

Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto.  The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited.  This is a presentation of Kennedy Capital Management, Inc.  Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in Kennedy Capital Management’s presentation thereof.   

The Russell 3000® Value Index measures the performance of the broad value segment of the US equity value universe. It includes those Russell 3000 companies with relatively lower price-to-book ratios, lower I/B/E/S forecast medium term (2 year) growth and lower sales per share historical growth (5 years). The Russell 3000® Value Index is constructed to provide a comprehensive, unbiased and stable barometer of the broad value market. The index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect value characteristics.

The Russell 3000® Value Index is used as the benchmark.  The Index is unmanaged and represents total returns including reinvestment of dividends.  The benchmark is used for comparative purposes only and generally reflects the comparable risk or investment style of the Firm’s strategy.  The investment portfolios underlying the Index are different from the investments in the portfolios managed by the Firm. Certain accounts may also use other benchmarks not listed in the GIPS composite report. The Verification and Performance Examination Report does not cover the benchmark returns included in the GIPS composite report.

The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. According to our Annual Survey of Assets, an estimated USD 15.6 trillion is indexed or benchmarked to the index, with indexed assets comprising approximately USD 7.1 trillion of this total (as of Dec. 31, 2021). The index includes 500 leading companies and covers approximately 80% of available market capitalization.