Fundamentals Took a Back Seat
Small-cap stocks retreated amid market volatility with value stocks dramatically outperforming their growth peers. Geopolitical uncertainty and rising interest rates weighed disproportionately on small caps as investors worried that smaller companies would have more trouble accessing capital and financing their operations. We also saw companies reporting strong earnings and raising guidance but still declining as factor rotation and macro events drove markets and not earnings.
We maintain a prudently diversified portfolio of companies that we believe represent compelling process fits, companies with accelerating and sustainable earnings growth. Holdings include businesses benefiting from economies reopening, secular growth trends, and higher rates and inflation. We expect volatility to remain elevated in the short term, and we seek to take advantage of dislocations in the market. We also believe it is critical to take a balanced approach to both risks and opportunities in what continues to be a very uncertain environment.
Hear more from our investment team. Read key takeaways from the replay below.
Key Takeaways
Rising Rates and Financials
Select holdings in banks and insurance industries that were more growth-oriented detracted from the strategy’s returns during the quarter. During the period, our process led to a shift in exposure toward companies better positioned to gain from rising interest rates. We have a preference toward insurance companies that could benefit from higher rates but also have relatively defensive, recurring revenues.
Opportunities From Disruptions
As is always the case, new market dynamics create new opportunities, and we’re focused on where we see accelerating and sustainable earnings growth—not short-term trends. For instance, we don’t expect the sanctions on Russia and Belarus, which together account for 30%-35% of the potash market, to be lifted anytime soon. We’ve taken a position in a company based in Germany that appears poised to take up the slack.
Many companies are also looking to improve management of supply chains and inventory. This is benefiting select software companies, including those involved with managing logistics and ones that help retail companies better manage their suppliers and online platforms.
Shifting Consumer Preferences
Consumers are shifting their spending to experiences and activities where more socialization is involved. Stay-at-home trends are fading in favor of a return to more normalized, in-person interaction. This benefits many brick-and-mortar businesses and experiential companies, including travel and leisure. Many leisure companies faced a challenging 2021 but are now seeing earnings accelerate off a low base. On the other hand, the demand outlook for discretionary products has been negatively impacted by inflationary pressures and geopolitical events, particularly in Europe.
We’ve adjusted our positioning in the consumer discretionary sector, reducing exposures in specialty retail and luxury while adding positions in corporate and leisure travel, hotels and gyms.
Months Ahead
Small-cap valuations remain attractive relative to large caps, and we believe the long-term outlook for earnings growth supports small caps. However, we expect to see substantial divergence in earnings growth from a sector and regional perspective. The sectors that previously drove improving earnings growth are unlikely to do so in 2022, whereas we may see stronger earnings growth from financials, materials and select companies that are beneficiaries of economies reopening.
This information is intended to be general in nature and is not personal financial product advice. Any advice contained in this document is general advice only and has been prepared without considering your objectives, financial situation or needs. Before acting on any information, you should consider the appropriateness of the information provided and the nature of the relevant financial product having regard to your objectives, financial situation and needs.
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The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.