Select SG Capital Cedar and Teton Strategies posted positive returns in Q3 while all major US indices ended the quarter at record lows for the year. The US equity market rally from mid-June through mid-July turned quite negative by mid-August, only to worsen throughout September. The Russell 2000 lost a staggering -9.58% in September, and the S&P 500 posted its worst month since March 2020. However, both the Cedar and Teton strategies held up well through the quarter, outperforming the broad market as well as their benchmarks.
SG CAPITAL THIRD QUARTER REVIEW
Volatility in the US markets was severe in the third quarter. Equities fell sharply in September resulting in the third consecutive negative quarter of performance for the general market. While we consider ourselves to be fundamental, bottom-up stock pickers, the global economic outlook is certainly a key variable today. Not only do we need to consider the potential changing demand environment but also how to manage risk in the portfolio under a recessionary environment. Fortunately, we have been through several macroeconomic cycles in our careers and have learned many valuable lessons. We believe our years of experience managing portfolios through difficult market environments contributed to our strong performance in the month of September and year to date.
Much of the volatility in the last three months was driven by uncertainties around interest rates and monetary policy. The unrest in the global economic market added to the list of investor concerns.
The result of the global turmoil and an aggressively tightening Federal Reserve has been a very strong US dollar. The US dollar has appreciated against the euro, yen, and pound by at least 15% in 2022 which is causing a ripple effect around the world. Given that 40% of S&P 500’s earnings originate from overseas , the dollar’s strong increase is significantly pressuring many US corporations’ bottom lines at a time when profit margins are compressing, and demand is slowing.
We are scrutinizing companies’ geographic exposure to understand the currency translation risk to their income statements but also the potential disadvantage if they have local competitors in a given international market.
SG DEFIES SMALL CAP WEAKNESS:
The majority of SG Capital Cedar Street and Teton Strategies’ exposure is to small and mid capitalization companies. This universe has experienced incredible volatility in 2022 with the average member of the Russell 2000 index seeing a 46% decline from their 52-week-high. While the Russell 2000 experienced a dramatic up and down during the quarter, select Cedar Street and Teton Long Short Strategies produced consistent returns to end the quarter with positive performance. We were able to generate alpha in the portfolios and our strong stock selection helped drive results.
LOOKING FORWARD to Q4 2022: Narratives worth considering
Will the market’s anxieties about corporate profitability come to fruition this earnings season? So far, most of the damage in the market has been a result of valuation compression as opposed to earnings weakness. The question now is will earnings revisions down be more severe than the market has already priced in? Importantly, if economic numbers start to show signs of a slowdown with inflation retreating, will the Federal Reserve pivot? Our view is that a less-hawkish Fed could result in a market rally, but we have no view on when or if this will be the case. Despite plenty of near-term market uncertainty, we have long-term confidence in our investing strategy and ability to produce positive performance regardless of the macro environment.
Our investment strategy never hinges on timing the market, and we have been successful in producing alpha despite market conditions.