Pricey Markets, COVID-19 and the Benefits of Quality Investing
The long running bull market was punctuated by a sharp correction in major U.S. markets last week, with uncertainty caused by the increasing spread of the COVID-19 outbreak. As often happens in such corrections, investors appeared to broadly sell risk assets in the early days followed by a more discriminate selling that hit stocks of lower quality businesses with greater impact.
What we believe:
Stocks entered 2020 at relatively high valuations and in the early weeks of the New Year headed higher still. Many investors were in search of a trigger to sell what was becoming an overbought market. Uncertainty brought about by the COVID-19 outbreak served as that trigger, causing some investors to head to the higher ground of U.S. Treasuries and other safe harbors. We face both a public health crisis and one that impacts the economy and the markets.
While it is difficult to say how the COVID-19 outbreak of 2020 will impact the global economy, we know that markets and supply chains are more global than they were in the SARS outbreak in 2003. China stands as the world’s largest exporter of merchandise and is firmly integrated into the global supply chain. U.S. small capitalization companies were more insulated during previous outbreaks than today; both the supply chains and demand from end markets for products of smaller companies will be impacted by our current crisis.
The Federal Reserve has limited ammunition to counter shocks such as the COVID-19 outbreak, but we believe there is a good chance it will cut rates to stimulate growth in the economy and calm investors. Chairman Jerome Powell issued a statement to reassure investors on Friday noting the “evolving risk” that exists to economic activity and how the Fed would “act as appropriate to support the economy.”
Where we maintain our focus:
Ballast remains concentrated on its beliefs that company fundamentals matter and quality businesses serve long term investors well. Many well-known companies have already issued guidance that near-term sales results will be impacted by disruptions due to the COVID-19 and more announcements of this type will follow in the coming weeks. High quality and low-quality businesses alike will be impacted in the near term, yet high quality companies have advantages that benefit them in challenging environments like the one we face today.
Ballast continually monitors the business performance of its holdings; current market disruptions make that due diligence more critical. Squarely in the middle of the present challenges are Ballast holdings in the technology sector such as Skyworks Solutions, Inc. (SWKS) and HollySys Automation Technologies (HOLI).
Skyworks, a key holding in the Ballast Quality Value Midcap Strategy, is a leading developer and manufacturer of semiconductor chips for the mobile product industry and is a prime beneficiary of megatrends such as the 5G rollout, the internet of things and mobility. Risks include its heavy exposure to client Apple and intense competition in the radio frequency chip market, yet the company’s high returns on invested capital, absence of debt and reasonable stock valuation all stand as buffers to these threats as well as the near term disruptions from COVID-19.
HollySys, a Beijing-based holding in the Ballast Quality Value Smallcap Strategy, is one of the major suppliers of process control systems and high-speed railway signaling systems in China and is benefitting from the long-term upcycle in China’s demand for industrial automation. Competitive advantages that include technology patents, brand recognition and its vast service network help to support mid-teens returns on invested capital. We believe these attributes and the reasonable valuation of HollySys stock make it a compelling holding.
The objective of Ballast Equity Management is to reward clients with performance that is above our benchmarks and peers over a full market cycle with less volatility, offering a smoother ride toward achieving each client’s investment goals. A key ingredient to providing this smoother ride is downside protection; falling less than the broader market in times such as we are currently experiencing. Ballast discusses this in its white paper Volatility – A Key Hurdle in Building Long-Term Wealth and we have been successful in doing this, to-date, as is reflected in the up market and down-market capture data below.
|Strategy||Up Market Capture||Down Market Capture|
|BQV Smallcap Strategy||98.35%||82.01%|
|BQV Midcap Strategy||103.82%||79.57%|
|Ballast Select Value||104.65%||80.97%|
We are confident that companies possessing strong balance sheets and high returns on invested capital supported by durable competitive advantages will provide the stability desired in the portfolios of long-term investors. Valuation – what we pay for shares in each company we own – plays a critical role in constructing portfolios of these businesses and is an important step in the Ballast investment process.
While the market correction has been swift and the near-term is uncertain, we have seen each of the three Ballast Quality strategies outperform to-date through Friday, February 28. Additionally, each strategy has bettered its respective benchmark for the first two months of 2020. Please visit www.ballastequity.com for additional information on Ballast Equity Management, its management team and our strategies.
Up Market Capture and Down-Market Capture are calculated relative to the primary index for each strategy and is calculated from the inception date of each strategy. Ballast Quality Value Smallcap Strategy is calculated against the Russell 2000 Value Index and its inception date was June 30, 2017. Ballast Quality Value Midcap Strategy is calculated against the Russell Mid Cap Value Index and its inception date was June 30, 2016. Ballast Select Value Strategy is calculated against the Russell 2500 Value Index and its inception date was July 6, 2017.
An investment with Ballast Equity Management (BEM) should not be construed as an investment in a program that seeks to replicate, or correlate with, these indices. Market conditions vary between the BEM products and these indices. Furthermore, these indices do not include any transaction costs, management fees, and other expenses, as do the BEM Products. Lastly, BEM may invest in strategies and positions that are not included in these indices.
No client or potential client should assume that any information presented should be construed as personalized investment advice. Personalized investment advice can only be rendered after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures. Investing carries risk of loss.
Ballast Equity Management, LLC is a registered investment advisor. For additional information about the firm and its professionals please visit the SEC’s website at www.adviserinfo.sec.gov