Dear Fellow Shareholders,
Market volatility reared its ugly head in the waning weeks of the first quarter of the new year as investors began to fear a weakening economic outlook. Also, significantly troubling investors was the President’s stated objective to implement a new tariff regime that could disrupt global trade flows and inflame tensions with friend and foe alike. The Trump Administration’s intentions are to migrate manufacturing and supply chains back into the United States, level the playing field relative to other nations and shift revenue generation from income taxes to a consumption-based tax on imports. Unfortunately, confusing and often conflicting messaging around the tariff plan left investors puzzling over how to position themselves. Indeed, the ten-year Treasury yield declined rapidly during the period without Fed intervention. This seems like an unexpected outcome if the President makes good on his tariffs as it might make investors less willing to hold dollar-based assets in the long run. Secretary Bessent has the challenge of refinancing approximately 30% of outstanding government debt this year due to the unfortunate policy of his predecessor that shifted new issuance to the short end of the yield curve in an attempt to reduce interest burdens on previous budgets. Lower rates clearly help with the state of public finance, but depending on how we get there, it may require higher policy related investor pain thresholds.
In the first quarter U.S. equity markets fell sharply, a downturn led by the large cap technology stocks that dominate the S&P 500 benchmark, a phenomenon about which we have often expressed concern. The uncertainty in the U.S. seemed to spark a capital outflow for the first time in a long while as what was intended to be a “MAGA” market turned into a “MEGA” one as Europe outperformed the U.S. driven by reinvigorated defense and infrastructure spending. China and many emerging markets outperformed the U.S. as well. Japan stood out as the only other weak developed market. The top sector contributors to the index were healthcare, financials and energy while technology, consumer discretionary and communication services were the leading detractors.
During the quarter, ten-year Treasury yields fell, and the dollar weakened across most currency markets reacting to the prospect of tariffs. Oil prices declined slightly in the quarter even as natural gas rose sharply, in part due to colder than normal weather. Precious metals rose meaningfully, and other industrial commodities were also mostly higher in the quarter. Agricultural commodities were mostly lower aside from coffee which again was sharply higher.
Our Fund lost -5.11% on a net basis during the period compared to S&P 500, the Russell 1000 Value and Russell 3000 Value which returned -4.27%, 2.14% and 1.64%, respectively. Materials, energy, and healthcare were the largest contributing sectors to the portfolio while technology, industrials and communication services were the weakest. The top individual contributors were Newmont, Wheaton Precious Metals, Texas Pacific Land, Republic Services and Sony. Marvell Technologies, Rocket Labs, NVIDIA, Alphabet, and ServiceNow were the laggards.
During the quarter, we purchased AeroVironment Inc., an aerospace and defense company focused on manufacturing drones and related software systems. The Department of Defense (DOD) is transforming the way it procures its military needs as it struggles to meet its national security priorities. AeroVironment is one of a new class of contractors that has evolved to meet this changing industry structure and threat environment. Its shares had fallen out of favor due to perceptions that the Trump Administration would swiftly end the Russia/Ukraine conflict which had been a large source of demand, that the controversial Department of Governmental Efficiency (DOGE) might target its programs and that its planned merger with BlueHalo LLC might not close. Our view was that the company’s programs fit with a core priority of the DOD, the merger was likely to proceed as planned given the terms of the agreement and that as a result the impact from Ukraine was likely already reflected in the share price and less of an issue going forward as the combined company was even more well positioned vis a vis DOD needs. Moreover, the valuation had compressed to the point being below our estimates of intrinsic value.
Another purchase during the quarter was United Healthcare, the leading insurer and managed care provider. The entire managed care sector had fallen out of favor due to concerns about the new Administration’s healthcare policies, several widely publicized scandals involving denial of coverage for sick patients and general public outcry over rising premiums and difficulty navigating the healthcare system. Our view was that the company had not behaved outside of the law and the controversies were overblown. Moreover, valuations had declined to decade lows and a large discount to the market generally. As an industry leader with a strong business model, we believed the risk/reward to be quite favorable.
Other purchases in the quarter included Regeneron, Uber and Genuine Parts. We also added to several existing positions including Adobe, Amazon, Marvell, and Vertiv.
Several positions were sold outright during the period. These include Flex (where price approached our targets), Johnson & Johnson (where we found an idea we liked better in Regeneron), Nike (where continued weakness and tariff risks called into question our thesis), Novo-Nordisk and Disney. Others were trimmed, including AbbVie, Apple, Crane, NVIDIA, Paccar, Sony, and Walmart.
Looking ahead, tariff policy continues to loom large over investor sentiment. What was supposed to be an Administration focused on cutting taxes and regulations and unleashing American exceptionalism has become mired in picking fights with allies, creating solutions that are in search of a problem and causing our partners to doubt our commitments. If tariffs end up staying in place, they may enable a reordering of trade flows that benefits the U.S. in the long run by restoring our manufacturing base and protecting our supply chains. They might even prove to be a revenue source that could free up room to cut income, capital gains or estate taxes. Alternatively, they could be a grand bargaining chip to reform China’s abuse of trading and commerce norms across the globe or just a ruse to cool the economy enough to lower interest rates and enable the Treasury to refinance our national debt. The question facing policy makers is whether the cure is worse than the disease if it causes the rest of the world to question the stability of the U.S., the dollar’s status as reserve currency and/or cause investors to lose interest in dollar denominated assets, particularly Treasury Bonds. Indeed, the latter is probably what keeps us and Secretary Bessent up at night. James Carville, the Democratic political strategist once said “I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 baseball hitter, but now I would like to come back as the bond market.” He might be right about that as it is the one thing that probably cannot be controlled. It strikes us that this is the biggest risk for markets in what the President is seeking to accomplish.
Sincerely,
| Robert Kleinschmidt Portfolio Manager | Peter Shawn Assistant Portfolio Manager |
