Micro Cap – Q1 2022 Commentary
The Russell Microcap® Index declined 7.60% in the first quarter of 2022, in line with small cap’s (Russell 2000®) decline of 7.53% and lagging the S&P500®’s decline of 4.60%.
For the Russell Microcap® Index, the strength in commodity prices resulted in Energy and Materials being the strongest sectors. Within Energy, the impact from the conflict in Ukraine resulted in oil prices reaching a level that has not been seen in nearly a decade. Materials’ outperformance was driven by certain agricultural areas, primarily companies with fertilizer exposure, and robust performance within gold stocks as investors looked for safety. The largest detractors for the index were Health Care and Information Technology in the quarter.
For the first quarter of 2022, the KCM Micro Cap Composite returned -5.73% (gross of fees) and -5.91%, outperforming the Russell Microcap® Index, which returned -7.60%. The portfolio outperformed the benchmark in 5 out of 11 sectors, with stock selection adding to alpha in the first quarter.
The top performing group was Health Care. Communication Services and Real Estate were also meaningful contributors in the quarter. Offsetting this performance was our underweight in Energy, which unfavorably impacted performance, in spite of a positive contribution from stock selection in the sector. Materials and Consumer Discretionary were also meaningful detractors in the quarter.
For Q1 earnings, we expect most companies will have another quarter of mixed results, with many companies experiencing headwinds in January and February tied to the Omicron variant. However, we have already seen some companies announce results and discuss a rebound in March, which has been well-received by investors. While labor rates have re-based at higher levels, we have heard from a few management teams that hiring trends seem to have improved through the quarter. Given the labor-related productivity headwinds experienced by many companies throughout 2021, we are optimistic this may be an under-appreciated tailwind for the economy.
Offsetting these improvements is the impact of waning stimulus for consumers, which has already begun to impact pockets of the economy (primarily subprime credit). The KCM Micro Cap strategy has limited direct exposure to the industries we believe will be most exposed to the decline in stimulus. Lastly, we and the market, are expecting interest rate hikes throughout 2022. While higher interest rates will likely have some impact on overall economic growth, we don’t expect a significant impact for most of our companies given our focus on businesses that have an ability to improve returns by optimizing their current operations. Overall, we expect Q1 results to be “choppy,” which typically is an environment for us to find new investment opportunities at attractive valuations.
Thank you for your support, and please don’t hesitate to reach out with any questions or concerns.
|Christian McDonald, CFA®