Artemis Funds (Lux) – US Smaller Companies update

Source for all information: Artemis as at 30 June 2024, unless otherwise stated.

The quarter started with a degree of fear around inflation and its persistence with March data being released in April showing the third consecutive month of +0.4% core CPI.

We also saw the ISM manufacturing returning to expansionary territory and the non-farms payroll showing robust jobs growth, forcing the Federal Reserve to delay the prospect of rate cuts to later into the year. May proved to be a more supportive month from a macro perspective. Fed Chair Powell dismissed the notion that further rate hikes were on the table and core CPI came in cooler than previous months. There was also some easing in the geopolitical situation in the Middle East which to a degree calmed markets. June ushered in a series of rate cuts by other central banks, namely the ECB and the Bank of Canada. Whilst the Federal Reserve stood firm, the market became increasingly confident that there would be one cut before year end. This notion was given further support when CPI came in at its slowest growth rate since August 2021. 

Whilst the macro environment might have been cause for optimism, this was not reflected in the smaller company’s index, the Russell 2000, which returned -3.3% (in US dollar terms) over the quarter. From a sector perspective energy and consumer discretionary were the weakest, with consumer staples and telecoms the strongest. 

Performance

On the negative side, building materials company Builders FirstSource was weak on deteriorating housing start data. French fry business Lamb Weston was impacted by weaker than expected volumes. The company also implemented an ERP system that hampered its ability to fulfil volumes. We sold the holding. Less-than-truckload business Saia also held back performance because of weak tonnage at the start of the year. The company later announced a pick up in mid-quarter tonnage and the stock started to recover.

On the positive side, a good contribution came from Coherent, a leader in networking cabling and lasers, which stands to benefit from the significant investment in datacentres. Restaurant group CAVA also contributed positively, underpinned by impressive profits despite the more widespread weakness in consumer sentiment.

Activity

We sold our position in TFI International, the less-than-truckload business, on a weak Q1 earnings report. Despite our long-term belief in the trajectory of the business, we believe capital is best used elsewhere.

We reduced some of our housing related names such as Builders FirstSource, AZEK, and TopBuild on deterioration in housing data, as outlined above. We also took profits in stocks that have done well, including nVent, Comfort Systems and Western Digital, reallocating capital to areas with more appealing risk returns.

On the purchases side, we added within our financials exposure, examples are Jefferies (investment bank) and Jones Lang Lasalle (real estate broker). We have also added within our Industrials exposure with purchases in Regal Rexnord (electronic equipment), APi Group (construction), and Bloom Energy (industrial engineering) to name a few. Elsewhere we have introduced Kinsale Capital, a property & casualty insurance business that has a low-cost business model supported by a strong technology framework to evaluate insurance opportunities. We have also added Confluent, a software company, and Shift4 Payments, a company that offers an ecommerce enabling technology.

Outlook

Whilst the long-awaited US smaller companies rally is yet to materialise, our optimism in the asset class has not waned. It seems many investors are waiting for the first rate cut to get behind the asset class as this would usher in an easier funding environment for smaller companies. We however see plenty of businesses up the quality spectrum that can thrive despite higher rates because they have a unique position, as well as strong balance sheets.

To reiterate the case for US smaller companies…

• Their valuations relative to large caps are still at multi-decade lows.
• They are more domestically wired allowing us to capture the intricacies of American economy more directly.
• The breadth and depth of the market means that we can target specific themes such as housing shortage, AI investment, fiscal expenditure or onshoring more effectively.