The more difficult it is to take action in the market, the more likely it is to be successful." -Dick Davis.
The third quarter was marked by solid performance across most U.S. stocks, with notable gains in large-cap and small-caps. Despite some volatility in mid-August, the S&P 500 Index posted gains of 5.89% in the quarter and 22.08% on a year-to-date basis. Robust gains for the S&P 500 were supported by broad participation, with the equally weighted S&P 500 returning roughly 9.48% in the recent quarter to reflect a year-to-date gain of 14.91%. Much of the recent rally was fueled by the first interest rate cut in four years as the Federal Reserve telegraphed to the markets less concern over further inflation risk. As measured by the Russell 2000, small caps increased 9.27% in 3Q24 to finish the first nine months of the year up 11.17%. Strong performance among small caps was driven by financials, industrials, REITs, and healthcare sectors, which benefit from falling interest rates.
While we are not out of the woods yet, the base care for a soft economic landing started to take shape in 3Q24, as inflationary pressures moderated and economic conditions supported a reasonably stable employment trend. In response, cyclical stocks outperformed defensive stocks, resulting in positive relative performance in industrial, consumer discretionary, financial, and materials sectors. According to consensus estimates, S&P 500 earnings are expected to show positive year-over-year gains in 3Q24 of +4%, stemming from continued revenue growth and improving margins for many companies that previously struggled to pass on higher costs a year ago. According to FactSet data, the 12-month forward PE multiple for the S&P 500 was 21.4X at the end of September, expanding from 20.5X at the end of March to well above the 10-year average of 18.0X. The inverse of the current S&P 500 PE multiple is a forward earnings yield of 4.67%, above the 10-year treasury yield of 3.73% at the end of the recent quarter. It is worth acknowledging that the S&P 500 is technically less expensive today relative to the yield on the 10-year treasury than it was at the beginning of June as the earnings yield for stocks declined 0.05% and the bond yield contracted 0.69%.
Our recent discussions with public company management teams over the past few months have been mixed but have been cautiously optimistic in most cases. Although the U.S. economy appears in a holding pattern, consumer spending appears more erratic this year as low savings rates and rising credit card balances curtail discretionary consumption of some goods and services. On the positive side, business conditions have been much better than many feared at the beginning of the year. Furthermore, supply chains appear stable for most industries, and input costs have continued to moderate. Demand related to infrastructure spending, data centers, renewable energy projects, and the reshoring of manufacturing remains healthy. The housing market is slower than a year ago due to higher financing costs and affordability but is holding up better than feared in many regions due to a lack of existing homes for sale. As equity investors, we find ourselves in a business environment where active portfolio management becomes essential to navigate quickly changing business conditions across many sectors and position portfolios to potentially benefit from shifting trends and structural changes across different industries.
For the balance of 2024, we would not be surprised to see increased volatility resulting from geopolitical events abroad and uncertainty surrounding the November elections. While short-term market volatility can sometimes seem overwhelming, we expect the next few months to create opportunities for active portfolio managers pursuing mispriced stocks. As a result, our investment team is laser-focused on the fundamentals of individual stock selection and the prospects for future earnings power. While many economic pundits have predicted a U.S. recession for the past couple of years that has yet to materialize, we have observed that some sectors, such as financials, energy, and industrials, have already experienced an earnings recession or at least a significant contraction in profit margins over the past 18 months. Given the prospects for a more normalizing environment for inflation and interest rates, we would not be surprised to see new leadership emerge within the market or at least a broader number of stocks participating in any upside from earnings growth over the next twelve months.
In summary, we are not focused on predicting short-term fluctuations in interest rates, foreign currencies, or commodity prices. Instead, we are concentrating on prevailing trends and, more importantly, the earning power of our portfolio companies within their unique industries. Consequently, the investment team at Hodges Capital is diligently seeking bargains in companies that we believe are well-managed and steer their own course through ingenuity and well-planned business decisions rather than relying on day-to-day market momentum. Despite the many uncertainties in the global economy and political landscape in 2024, we are overweighting our portfolios with growth and value stocks that we anticipate will create long-term shareholder value in today's environment. During these uncertain times, we want to reassure Hodges Funds investors that our fundamental investment approach remains unwavering. Furthermore, we see the current environment as an excellent opportunity for our portfolio managers to carefully select individual stocks that we believe will provide lasting value for our shareholders. Your trust in us is paramount, and we are committed to maintaining our investment discipline.
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.
The return for the Hodges Small Cap Fund amounted to a gain of 8.85% in the third quarter of 2024, compared to an increase of 9.27% for the Russell 2000 Index. The Small Cap Fund's year-to-date performance as of September 30, 2024, amounted to a gain of 16.78% compared to 11.17% for the Russell 2000 Index during the same period. The Small Cap Fund's one-year performance amounted to an increase of 26.25% compared to 26.76% for the Russell 2000 Index during the same period. Although small-cap stocks have now underperformed large-cap stocks for the better part of the past decade, we still consider the current risk/reward for holding quality small-cap stocks 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 51 positions on September 30, 2024. The top ten holdings amounted to 35.49% of the Fund's holdings and included Matador Resources (MTDR), Texas Pacific Land Corp (TPL), Eagle Materials Inc (EXP), Taylor Morrison Home Corp (TMHC), SunOpta Inc. (STKL), On Holding Ltd (ONON), Norwegian Cruise Line Holdings (NCLH), Shoe Carnival Inc (SCVL), Halozyme Therapeutics (HALO) and Cleveland-Cliffs Inc (CLF).
The Hodges Fund's third quarter 2024 return amounted to a gain of 3.73% compared to 5.89% for the S&P 500 Index. The year-to-date return amounted to 9.51% compared to a 22.08% return for the S&P 500 Index. Over the past nine months, underperformance has been attributed to the portfolio's underweight exposure to the seven largest momentum stocks in the S&P 500. The Hodges Fund's turnover was average in the recent quarter as we have carefully updated the portfolio holdings, moving 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 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 41. On September 30, 2024, the top ten holdings represented 45.70% of the Fund's holdings. They included Uber Technologies (UBER), Texas Pacific Land Corp (TPL), Matador Resources Co (MTDR), DraftKings Inc (DKNG), Freeport McMoran Inc (FCX), Norwegian Cruise Line Holdings (NCLH), SharkNinja, Inc. (SN), On Holding (ONON), Wynn Resorts (WYNN), and Nvidia Corp (NVDA).
The Hodges Small Intrinsic Value Fund experienced a gain of 5.54% in the third quarter of 2024 compared to an increase of 10.15% for its benchmark, the Russell 2000 Value Index. The Small Intrinsic Value Fund's year-to-date and twelve-month returns amounted to 3.99% and 15.92%, respectively, compared to 9.22% and 25.88% for the Russell 2000 Index during the same period. The Fund's recent underperformance relative to the benchmark was impacted by lagging performance among a handful of consumer discretionary and energy stocks that were out of favor in the quarter. The number of positions held in the Fund decreased by one, resulting in 46 holdings at the end of the recent quarter. On September 30, 2024, the top holdings represented 33.51% of the Fund's holdings. They included Eagle Materials Inc (EXP), Shoe Carnival Inc (SCVL), SunOpta (STKL), Banc of California (BANC), Triumph Financial (TFIN), Ethan Allen Interiors Inc (ETD), Taylor Morrison Home Corp (TMHC), Texas Capital Bancshares (TCBI), Halozyme Therapeutics (HALO), and Home Bancshares (HOMB).
The Hodges Blue Chip Equity Income Fund was up 6.93% in the third quarter of 2024, compared to 6.08% for its benchmark, the Russell 1000 Total Return Index. The Blue Chip Fund's year-to-date return amounted to 25.36% compared to 21.18% for the Russell 1000 Total Return Index. Positive relative performance in the recent quarter and year-to-date period was attributed to stock selection and sector allocation. Vistra (VST) and Walmart (WMT) were among the top stocks contributing to the Fund's recent relative performance.
We believe the current investment landscape offers ample opportunities among 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 28. The top ten holdings at the end of the quarter represented 49.58% of the Fund's holdings and included Apple Inc (AAPL), Nvidia (NVDA), Walmart Inc (WMT), Microsoft Corp (MSFT), Caterpillar Inc (CAT), Taiwan Semiconductor (TSM), Broadcom Inc (AVGO), Morgan Stanley (M.S.), Exxon Mobil Corp (XOM), and Amazon.com Inc (AMZN).
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. Moreover, our entire investment team is highly committed to rigorously studying companies, meeting with management teams, and observing trends to navigate today's ever-changing financial markets. Feel free to contact us directly if we can address any specific questions.
Learn more about Hodges Funds:
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.