Issue link: https://resources.envestnet.com/i/1528445
4 FOR INVESTMENT PROFESSIONAL USE ONLY John Parsons Panic Selling Creates Opportunity As confirmation that corporate leaders do not feel the world is coming to an end quite yet, insider- buying in the small cap market is at an all-time high, far exceeding levels ever seen before. There have been three pockets of significant insider-buying in the last eighteen months, which have coincided with increased market volatility – Dec. 2018, Aug. 2019, and Mar. 2020. The largest recent activity has been disproportionately focused in the cyclical areas where stock prices have been crushed, especially in the regional banks space. Banks are far better positioned this time around than was the case during the 2008 financial crisis, but their stock prices are trading as if they will never make money again. This will probably not be the case. They likely won't all be going out of business. Today, banks are not levered to the same extent they were in 2008, capital and liquidity is far higher, and fiscal stimulus is being better received by the public than were the bank bailouts a decade ago. On the other hand, insider buying in Utilities has been muted relative to historical trends, as investors have flocked to the sector for safety, pushing up prices, and reducing relative valuations. Nevertheless, value stocks continue to be underappreciated compared to their growth counterparts. Value stocks, especially small cap value, are trading at p/e multiples far below their 20-year averages – approximately 65% in the case small cap value. This compares to an average near 100% across the growth market cap spectrum. This valuation disparity between growth and value is entering its tenth year. While the "chicken trade" in low volatility stocks (e.g. utilities, REITs, insurance companies) has worked the last couple of years, valuations are also being stretched. Maybe some of the more beaten down areas of the market will finally have their day. David Chandler Being Greedy When Others are Fearful The best value investments are quality companies suffering fixable problems. This is easy to say, but solvable problems are only obvious in retrospect and almost never so in the present. And so we come to the present state of the Energy sector. Energy is currently suffering the worst industry fundamentals in its modern history, even worse than the mid-80s. Oil demand is way down due to the coronavirus outbreak. China's shutdown got the ball rolling on the demand decline, and now that we are all quarantined, it's in a freefall. To add to the industry's problems, a price war was kicked off between Saudi Arabia and Russia after an OPEC meeting earlier month. The end result is a glut of supply oil prices in the mid $20s, and everybody losing money. The red ink flows. We expect our managers have lost or probably will lose money in these stocks near term. How should we judge them though? If value managers believe the words they say, both with regard to buying cheap stocks AND being long-term investors, it's hard to argue with them adding to their holdings at current prices. If one believes in reversion to the mean and that modern life will go on, it's not hard to envision the oil pendulum swinging the other way. The hard part is predicting the "when", not the "if" of this reversal. Ultimately, if we believe our managers are good at picking investments but bad at timing, then we should not penalize them for losing money in this sector in the near term. We want value managers buying stocks that are cheap. If cyclical companies at generational lows are not cheap stocks, it's hard to know what is. We should not be surprised to see value managers increasing their allocation to this sector. Indeed, we should be encouraged by it.