To Our Investors and Friends,
The S&P 500 Index (S&P 500) expanded by 8.3% in the second quarter powered higher by the sectors that dropped the most last year – technology, consumer discretion and communication services. Oil fell almost 7% to $71 a barrel as global demand remained muted. The 10-year Treasury bond increased 35 basis points in the quarter, ending at 3.9%, while the 2-Year Treasury moved up 81 basis points, finishing 88 basis points above the 10-year. As has been the case since the beginning of the year, a handful of mega-cap and larger technology companies are driving the market higher, while many smaller companies are modestly up this quarter. As a result, the Russell 1000 Growth was up 12.8% and the Russell 2000 Growth was up 7.1%. Value again lagged as the Russell 1000 Value expanded 4.1% and the Russell 2000 Value indexes were up a modest 3.2%.
This quarter’s remarkable recovery should come as no surprise, given the brutal market sell-off that preceded it. Beginning in November 2021, the market aggressively sold off technology, consumer discretionary and communications services stocks as much as 70-90% in response to the largest interest rate increases we have experienced in 40 years. Starting in January 2023, select stocks made astonishing comebacks, some achieving all-time highs as their business fundamentals strengthened. The chart below highlights the “Magnificent Seven” stock changes over this timeframe. We believe this group will ultimately prove to be the first movers of the new bull market and should be followed by the rest of the market in the coming quarters.
We believe that higher interest rates should have led to 25-35% contractions during this period, not the much steeper declines that took place. We think there are two culprits: algorithms and primal instincts. Algorithms are programmed to buy and sell stocks in a systematic way and often with no regard to the impact such actions have on the stocks. Many of these algorithms are programmed by freshly minted computer science majors that have no experience with the markets making them simple in design. In aggregate, these quantitative investors are now responsible for well over $1 trillion in assets under management.
The other culprit in the rapid decline and then rise in stocks is undisciplined stock participants that react to buying and selling pressures initiated by the algorithms. Dramatic moves tend to ignite our most primal instincts, compelling us to move as a group despite the negative consequences to individual participants. Investors show obvious disinterest in stocks that have sold off, yet enthusiastically chase after stocks that bounce. This is a basic instinct that we must fight, especially when the algorithms exacerbate the situation. Algorithms will only get more intelligent over time and could chase us out of and into stocks at an even greater cost to our portfolio returns.
At Kingsland Investments, we remain highly disciplined when seeking out and investing in what we believe are promising companies. Our long-term, fundamentally-based process allows us to take advantage of the short-term vacillations in the market, whether they are driven by algorithms or nervous investors that tend to buy high and sell low. Over time, we believe patience has the potential to produce performance that is reflective of the strong business growth we seek. With a little bit of luck, we strive to add to this strong performance by taking advantage of the emotional buying and selling that drive short-term market moves like that which we have experienced over the last two years.
All the best to you,
Arthur K. Weise, CFA
The views expressed are those of Kingsland Investments as of July 1, 2023, and are not intended as investment advice or recommendation. For informational purposes only. Investments are subject to market risk, including the loss of principal. Past performance does not guarantee future results. The stocks mentioned are for illustrative purposes only and are not a recommendation to buy or sell. There can be no assurances that any of the trends described herein will continue or will not reverse. Past events and trends do not imply, predict or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index.