The third quarter of 2023 proved lackluster for most U.S. stocks as the market digested higher for longer interest rates and developing headwinds facing the consumer. The S&P 500 fell 3.27%, and the NASDAQ-100 Composite was down 4.12% in the recent quarter to reflect year-to-date returns of 13.07% and 26.3%, respectively. Year-to-date strength in the broader market indexes has primarily resulted from momentum in a concentrated number of mega-cap growth stocks, with the top seven stocks in the S&P 500 making up 28% of the Index and amounting to 65% of its year-to-date return.   As a result, the S&P 500, on an equally weighted basis, was up only 1.79% year-to-date for the period ending September 30, 2023. As measured by the Russell 2000, small-caps tumbled 5.13% in the quarter, again lagging due to their cyclical sensitivity and exposure to regional banks. Additionally, value stocks continued to underperform growth stocks in the face of economic uncertainty and tighter credit conditions. Despite a treacherous environment for stock picking, all four Hodges Mutual Funds managed to meet or outperform their benchmarks in the recent quarter. This relative performance was primarily attributed to careful individual stock selection, emphasizing companies with solid business fundamentals and reasonable valuations.  

It's been eighteen months since the Fed started its aggressive tightening cycle, which has led to a widely anticipated recession that has been slow to materialize. However, we are finally seeing some evidence of cracks in economic conditions as consumer credit card balances build and student loan payments resume. Although ample uncertainty surrounds the long-term trajectory of interest rates and inflation, near-term credit conditions are more restrictive, resulting in higher bond yields and lower PE multiples for stocks. According to the most recent data published by FactSet, the S&P 500 traded at approximately 17.9X forward earnings estimates at the end of the recent quarter compared to 19.1X at the beginning of the third quarter and a 5-year average of 18.7X. The inverse of the current S&P 500 PE multiple reflects an earnings yield of 5.59%, which moved closer during the recent quarter to the rising 10-year Treasury yield of 4.58% at the end of the quarter. However, it is essential to consider that the PE multiple for the S&P 500 is deeply influenced by the information technology sector and those top seven stocks now known as the “Magnificent Seven” by Wall Street pundits.

At Hodges Capital, our process for individual stock selection involves a multitude of factors. However, three of the most important factors for individual stock selection in a rising interest rate environment are balance sheets, balance sheets, and balance sheets. This is not to diminish the importance of the future earnings trajectory and cash flow in our analysis. Moreover, the inevitable contraction in bank lending and tighter credit conditions will be challenging for companies with heavy debt burdens or business models dependent on easy access to low-cost credit. We would point out that many businesses have spent the past year cutting costs, scrutinizing capital expenditures, tightening supply chains, and cautiously managing inventories in anticipation of a slowdown. This sometimes creates opportunities for companies with conservative balance sheets, low-cost operations, and ample liquidity to weather a downturn and, in many cases, take market share from weak competitors.

Our recent discussions with public company management teams over the past few months suggest that supply chains are stable, and many input costs have recently moderated. Although the U.S. economy remains near full employment, consumer spending has become more erratic this year as excess savings built up during the pandemic are no longer a tailwind, and inflation curtails discretionary consumption of some goods and services. The housing market has slowed due to higher mortgage rates but is holding up better than feared in many regions of the U.S. due to a lack of existing homes for sale. Furthermore, many facets of manufacturing appear to be experiencing a renaissance due to onshoring and nearshoring supply chains and increased infrastructure-related spending. It is also important to note that not every economic slowdown looks the same, and not every business will be affected the same by potential macro headwinds. In this environment, active portfolio management becomes essential to navigate quickly changing business conditions across many sectors and position portfolios to potentially benefit from shifting economic trends and structural changes across different industries.

As we enter the final quarter of 2023, our portfolios remain laser-focused on fundamental investing and individual stock selection. Our investing approach involves spending little time predicting short-term fluctuations in interest rates, foreign currencies, or commodity prices. Instead, we pay close attention to prevailing prices and, more importantly, the pricing power that our portfolio companies exhibit within the goods and services they produce. For many businesses, tighter credit conditions and a slowdown in demand could adversely impact profit margins and revenues in the months ahead. As a result, the investment team at Hodges Capital is rigorously looking for bargains in businesses that we believe are well-run and control their destiny by relying on ingenuity and well-calculated business decisions rather than day-to-day momentum in the economy or stock market. Despite challenging macro conditions, we are overweighting our portfolios with growth and value stocks that we expect to create long-term shareholder value in today’s environment.

In these uncertain times, we want to reassure our valued investors in the Hodges Funds that our fundamental investment approach remains steadfast. Our commitment to identifying companies with strong business operations, exceptional management teams, and fair valuations remains unwavering. Moreover, we view the current landscape as an opportune moment for our portfolio managers to meticulously handpick individual stocks that we believe will yield lasting value for our shareholders. Your trust in us means everything, and we're dedicated to upholding our investment discipline.

Returns (% Retail Class) as of 9/30/2023

Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. The current performance of the Funds may be lower or higher than the performance quoted. Performance data current to the most recent month-end may be obtained by calling 866-811-0224. The Funds impose a 1.00% redemption fee on shares held for thirty days or less (60 days or less for Institutional Class shares). Performance data quoted does not reflect the redemption fee. If reflected, total returns would be reduced. Performance reflected is net of all other fees and expenses.

Hodges Small Cap Fund (HDPSX)

The return for the Hodges Small Cap Fund amounted to a loss of 5.13% in the third quarter of 2023, compared to a loss of 5.13% for the Russell 2000 Index. The Small Cap Fund's year-to-date performance as of September 30, 2023, amounted to a gain of 6.24% compared to 2.54% for the Russell 2000 Index during the same period. The Small Cap Fund's one-year performance on September 30, 2023, amounted to a gain of 19.02% compared to 8.93% for the Russell 2000 Index during the same period. Although small-cap stocks have again underperformed large-cap stocks this year, we view the current risk-reward for holding quality small-cap stocks as attractive. While small-cap stocks tend to experience greater volatility during market turmoil, we expect this segment to generate above-average relative risk-adjusted returns over the long term.  

The Hodges Small Cap Fund remains well diversified across industrials, transportation, healthcare, technology, and consumer-related names, which we expect to contribute to the Fund's long-term performance. The Fund recently took profits in several stocks that appeared overvalued relative to their underlying fundamentals and established new positions with an attractive risk/reward profile. The Fund had a total of 40 positions on September 30, 2023. The top ten holdings amounted to 37.67% of the Fund's holdings and included Matador Resources (MTDR), SM Energy Co (SM), Eagle Materials Inc (EXP), Texas Pacific Land Corp (TPL), Encore Wire Corp (WIRE), On Holding (ONON), Cleveland-Cliffs Inc (CLF), Kimball Electronics Inc (KE), Taylor Morrison Home Corp (TMHC), and Vista Outdoor Inc (VSTO).

Hodges Fund (HDPMX)

The Hodges Fund's third quarter of 2023 return amounted to a gain of 0.68% compared to a decrease of 3.27% for the S&P 500 Index. The year-to-date return amounted to 15.00% compared to a 13.07% return for the S&P 500 Index. The one-year return for the period ending September 30, 2023, amounted to a gain of 30.11% compared to an increase of 21.62% for the S&P 500 Index. Although the portfolio has been underweight among the seven largest momentum stocks in the S&P 500, positive performance over the past twelve months has been attributed to a handful of industrial, energy, and technology stocks. The Hodges Fund’s turnover was again elevated in the recent quarter to take advantage of volatile market conditions. We have upgraded many portfolio holdings into stocks that we believe offer above-average returns relative to their downside risks over the next twelve to eighteen months.

The Hodges Fund's portfolio managers remain laser-focused on investments where we have the highest conviction based on fundamentals and relative valuations. The number of positions held in the Fund at the end of the recent quarter was 40. On September 30, 2023, the top ten holdings represented 47.19% of the Fund's holdings. They included Matador Resources Co (MTDR), Uber Technologies (UBER), Encore Wire Corp (WIRE), On Semiconductor (ON), Texas Pacific Land Corp (TPL), Shift4 Payments Inc (FOUR), DraftKings Inc (DKNG), On Holding (ONON), Upland Software Inc (UPLD), and Micron Technology Inc (MU).

Hodges Small Intrinsic Value Fund (HDSVX)

The Hodges Small Intrinsic Value Fund experienced a loss of 3.12% in the third quarter of 2023 compared to a loss of 2.96% for its benchmark, the Russell 2000 Value Index. The Fund’s year-to-date and twelve-month returns amounted to 6.15% and 13.42%, respectively, compared to -0.53% and 7.84% for the Russell 2000 Value Index. The Fund's solid relative performance over the past year has been attributed to several of the Fund's material, energy, and industrial stocks. The number of positions in the Fund decreased from 49 to 48 during the recent quarter. The top 10 holdings at the end of the recent quarter included Eagle Materials Inc (EXP), Triumph Financial Inc (TFIN), Vista Outdoor Inc (VSTO), Shoe Carnival Inc (SCVL), Chord Energy Corp (CHRD), Hilltop Holdings Inc (HTH), Taylor Morrison Home Corp (TMHC), Ethan Allen Interiors Inc (ETD), Texas Capital Bancshares Inc (TCBI), and Propetro Holding Corp (PUMP).

Hodges Blue Chip Equity Income Fund (HDPBX)

The Hodges Blue Chip Equity Income Fund was down 2.34% in the third quarter of 2023, compared to a loss of 3.15% for its benchmark, the Russell 1000 Total Return Index. The Fund experienced a year-to-date return of 11.53% compared to 13.01% for the Russell 1000 Total Return Index. The return for the twelve months ending September 30, 2023, amounted to 24.36% compared to a gain of 21.19% for the Russell 1000 Total Return Index. Laging relative performance in the recent quarter was attributed to sector allocation among energy and technology. However, the current investing landscape offers attractive, high-quality, dividend-paying stocks with solid upside potential. We expect underleveraged balance sheets and corporate profits across most blue-chip stocks to support stable dividends over the next several years. The Blue Chip Equity Income Fund remains well-diversified in companies that we believe can generate above-average income and total returns on a risk-adjusted basis. The number of positions held in the Fund at the end of the recent quarter was 31. The top ten holdings at the end of the quarter represented 44.60% of the Fund's holdings and included Apple Inc (AAPL), Microsoft Corp (MSFT), Exxon Mobil Corp (XOM), Nvidia (NVDA), Novo Nordisk (NVO), Deere & Co (DE), Tesla (TSLA), Goldman Sachs Group Inc (GS), Costco Wholesale (COST), and Walmart Inc (WMT).

In conclusion, we remain optimistic regarding the long-term investment opportunities surrounding the Hodges Mutual Funds. By offering four distinct mutual fund strategies covering most segments of the domestic equity market, we can serve most financial advisors and individual investors' diverse needs. Our entire investment team is rigorously studying companies, meeting with management teams, observing trends, and navigating today's ever-changing financial markets. Feel free to contact us directly if we can address any specific questions.

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The above discussion is based on the opinions of Eric Marshall, CFA, and is subject to change. It is not intended to be a forecast of future events, a guarantee of future results, and is not a recommendation to buy or sell any security. Portfolio composition and company ownership in the Hodges Funds are subject to daily change.  

The Fund’s investment objectives, risks, charges and expenses must be considered carefully before investing. The statutory and summary prospectuses contain this and other important information about the Hodges Funds, and it may be obtained by calling 866-811-0224, or visiting www.hodgesmutualfunds.com. Read it carefully before investing.

Mutual fund investing involves risk. Principal loss is possible. Investments in foreign securities involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks are greater for investments in emerging markets. Options and future contracts have the risks of unlimited losses of the underlying holdings due to unanticipated market movements and failure to correctly predict the direction of securities prices, interest rates and currency exchange rates. These risks may be greater than risks associated with more traditional investments. Short sales of securities involve the risk that losses may exceed the original amount invested. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer term debt securities. Investments in small and medium capitalization companies involve additional risks such as limited liquidity and greater volatility. Funds that are non-diversified are more exposed to individual stock volatility than a diversified fund.   Investments in companies that demonstrate special situations or turnarounds, meaning companies that have experienced significant business problems but are believed to have favorable prospects for recovery, involve greater risk.

Value investing carries the risk that the market will not recognize a security’s inherent value for a long time, or that a stock judged to be undervalued may be appropriately priced or overvalued.

Diversification does not assure a profit or protect against a loss in a declining market.

Fund holdings and/or sector allocations are subject to change at any time and are not recommendations to buy or sell any security.

Investment performance reflects fee waivers in effect. In the absence of such waivers, total return would be reduced.

The S&P 500 Index is a broad-based unmanaged index of 500 stocks that is widely recognized as representative of the equity market in general. The Russell 1000 Index is a subset of the Russell 3000 Index and consists of the 1,000 largest companies comprising over 90% of the total market capitalization of all listed stocks. The Russell 2000 Index consists of the smallest 2,000 companies in a group of 3,000 U.S. companies in the Russell 3000 Index, as ranked by market capitalization. The Russell 2500 Index consists of the smallest 2,500 companies in a group of 3,000 U.S. companies in the Russell 3000 Index, as ranked by market capitalization. The Russell 3000 Index is a stock index consisting of the 3000 largest publicly listed companies, representing about 98% of the total capitalization of the entire U.S. stock market. The Russell 2000 Value Index measures the performance of small-cap value segment of the U.S. equity universe. It includes those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. The Russell 2000 Value Index is constructed to provide a comprehensive and unbiased barometer for the small-cap value segment. The Index is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set and that the represented companies continue to reflect value characteristics. The NASDAQ Composite Index is an index of more than 3,000 common equities listed on the NASDAQ stock market. You cannot invest directly into an index.

Cash Flow: A revenue or expense stream that changes a cash account over a given period.

Price/earnings (P/E): The most common measure of how expensive a stock is.

Earnings Growth is not a measure of the Fund’s future performance. 

Hodges Capital Management is the Advisor to the Hodges Funds.

Hodges Funds are distributed by Quasar Distributors LLC.