After investors suffered through a painful 2022 in both equities and fixed income, 2023 started with a bang. In the U.S., for example, the Russell 2000 Index was up almost 14% as of February 2nd. Low quality stocks, as defined by returns on capital and profitability, led the charge. Unfortunately, inflation and rising interest rates continued to rear their heads, helping to halt valuation expansion, and contributing to the U.S. banking scare that hit in early March.
With regional banks shifting their attention to customer retention and balance sheet strength, lending standards tightened in North America. Certainly, the possibility of a recession continues to increase and stocks struggled into the close of the first quarter. On a relative basis, investors refocused on financial returns, profitability, and balance sheets to compensate for increased macroeconomic risks.
Falling stock prices across many sectors also means that a difficult period is being taken into account by investors. Whether and when a recession hits, and then how long or deep it is, remains unknown. It will only be known in hindsight.
Pembroke’s view is that its equity portfolios are reasonably valued and well capitalized. When we get past this challenging period and growth and earnings pick up, the investment team expects that some holdings will rise significantly from multi-year lows. Further, the balance sheet strength, which is notable in all of the firm’s equity products, gives the Pembroke team confidence that the firm’s holdings are well positioned to weather a storm and prosper thereafter.
It has been a long time since the investment community has lived through a period of sharply rising interest rates and dealt with central banks committed to managing inflation, even at the expense of economic growth. The rising “cost of money” has led to a recalibration of capital deployment and spending decisions. Companies are currently looking carefully at all their spending to ensure adequate financial returns.
When money was so low-cost that it felt “free” through 2021, there was a loss of discipline by companies and investors. The new economic and monetary backdrop should mean that disciplined management teams will face less pressure to grow at any cost and should result in less competition from companies who were spending without regard for profit.
Pembroke believes that its holdings will benefit over the next three to five years from this more rational approach to spending and investment. While the near term is difficult to predict, the multi-year upside from today’s price levels is compelling.
As always, Pembroke advises patience and urges calm during periods of market uncertainty or panic.
Other Articles Of Interest
This report is for the purpose of providing some insight into Pembroke and the Pembroke funds. Past performance is not indicative of future returns. Any securities listed herein, are for informational purposes only and are not intended and should not be construed as investment advice nor is it a recommendation to buy or sell any particular security. Factual information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Pembroke seeks to ensure that the content of this document is correct and up to date but does not guarantee that the content is accurate and complete and does not assume any responsibility for this. Pembroke is not responsible for decisions or actions taken or made on the basis of information contained in this document.