Market Shifts and Opportunities
The third quarter of 2024 was marked by a significant shift in market leadership, driven by weaker-than-anticipated labor reports and subdued inflation readings. This led to the Federal Reserve cutting interest rates by 50 basis points, its first cut since the beginning of the COVID-19 pandemic. The likelihood of further cuts and access to cheaper financing acted as a tailwind to the rotation away from generative AI beneficiaries and toward broader market leadership favoring small cap stocks.
Small Cap Performance
The benchmark Russell 2000 Index returned 9.27%, outperforming both the S&P 500 Index and the large cap Russell 1000 Index. The rotation away from IT companies and into other sectors also helped bolster the performance of value stocks, with the Russell 2000 Value Index returning 10.15%.
ClearBridge Small Cap Strategy
The ClearBridge Small Cap Strategy underperformed its benchmark in the third quarter, as detractors in the communication services and information technology sectors outweighed strong performance by several health care and consumer discretionary holdings. Stock selection in the communication services sector was a significant detractor, largely due to not owning Lumen Technologies, which skyrocketed after signing agreements with Microsoft and Corning.
Health Care and Consumer Discretionary Sectors
Stock selection in the health care sector was the greatest contributor to relative performance, with three of the top five individual contributors coming from the sector. Lantheus, which makes diagnostic and therapeutic products, rose sharply after the Centers for Medicare and Medicaid Services proposed changes to its reimbursement policies. Corcept Therapeutics saw its stock rise after strong earnings results and increased guidance for sales of Korlym, a hyperglycemia drug.
Election Uncertainty
The looming U.S. presidential election has created uncertainty in the market, with investors trying to anticipate the impact of different electoral outcomes on the economy and equity markets. We are paying close attention to the candidates’ approaches regarding taxes, tariffs, and immigration policies.
Probabilistic Approach
Rather than speculating on the election’s outcome, we apply a probabilistic approach to evaluating a wide range of possibilities and constructing our portfolio around strong companies with good balance sheets that are likely to persevere and prevail against the widest range of outcomes.
New Positions and Exits
Our largest new position during the quarter was Meritage Homes, which builds single-family attached and detached homes in the western and southeastern U.S. We also added a new position in Hain Celestial, which makes organic and natural products. We exited our position in Everi, which provides games, cash access, and customer relationship technologies to the casino industry.
Conclusion
Despite the uncertainty surrounding the election, we believe that our disciplined, bottom-up, fundamentals-based approach to investing will help us navigate the short-term volatility spikes. By employing a probabilistic approach and focusing on constructing a portfolio of strong companies with excellent balance sheets and compelling individual catalysts, we are well-equipped for the long-term.
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