The first quarter was positive, albeit mixed for U.S. equity markets. The S&P 500 rose 7.50%, as large cap technology stocks led the way higher with the Nasdaq composite up 17.05% in a reversal of its 2022 underperformance. Underneath the surface, this strong performance was concentrated in “mega cap” stocks as the ten largest companies in the S&P 500 accounted for the majority of the gains for the index. Conversely, small cap stocks underperformed this quarter, rising just 2.74%, with small cap growth stocks rising 6.07%.
In the first half of 2022, equity markets declined roughly 20% across both large and small caps as investors repriced equities in response to higher interest rates and in anticipation of a recession that has yet to occur. Stocks have been flat since the summer of 2022, as markets have moved up and down within a wide range, depending on whether an economic hard-landing or soft-landing scenario is in favor. It has been difficult to find a consistent trend other than those stocks that were down the most in 2022 have generally fared the best in 2023.
The economy has experienced a series of “rolling” sector recessions following the original COVID-19 shutdown. As the economy recovered in 2020, fueled by low interest rates and government stimulus, consumers splurged on housing, furniture, and other goods they could buy online, while fear of the virus severely restrained spending on in-person activity like restaurants and travel. Hotels, airlines and cruise lines suffered large losses. Restaurants and hotels were the first to return to profitability in 2021, airlines did so in 2022, and cruise lines are expected to achieve profitability in 2023. As those areas recover, consumer spending on goods is slowing as consumers shift their consumption mix back to services, and budgets are tighter due to higher inflation. For example, personal computer sales (a mix of business and consumer consumption) were off 29% in Q1 compared to the prior year, and sales of televisions and other consumer electronics are well off their peak sales. On the international front, China’s economy is reaccelerating following the end to their zero COVID policy. This will benefit US companies with operations in China. In contrast, Western economies broadly face headwinds due to the impact of rising interest rates. Like the stock market, the economic environment is currently positive, but mixed.
Companies that we own continue to report solid fundamental results with growing earnings and sales. In the most recent quarterly earnings reports (4Q 2022), the Shaker Investments Small Cap Growth Strategy achieved average/median sales growth of 18.3%/16.8% and operating earnings per share (EPS) growth of 31.7%/23.4% (GAAP EPS growth of 45.0%/32.2%). This exceeded the S&P 500 average of 5.3% sales growth and a -4.6% decline in operating EPS. We are confident that the relatively strong results for the strategy will continue. Even in a recession scenario, which has been top of mind for many investors, we expect similar relative outperformance for the fundamental results of our holdings, creating opportunities to gain market share and invest in future growth at the expense of competitors more focused on survival.