To Our Investors and Friends,
The S&P 500 ended the month of April down 4.2%, a minor contraction after a very strong first quarter result. It should come as no surprise that the Magnificent Seven significantly outperformed the rest of the market as investors continue to crowd into this narrow group of stocks. The 10-year Treasury Bond advanced to 4.69%, the second meaningful increase in consecutive months (39-basis points this month) as fears of an inflation resurgence dominate Wall Street. The 2-year Treasury ended the quarter 45 basis points higher to end at 5.04%. Oil fell slightly, finishing the month at $83 a barrel. The major stock indexes fell in the month, led once again by small cap. The Russell 1000 Growth declined 4.2%, the Russell 1000 Value fell 4.3%, the Russell 2000 Value was down 6.4%, and the Russell 2000 Growth dropped 7.7%.
We have discussed the significant disparity between the performance of large cap companies versus small cap companies for some time now. In fact, the difference in performance between the Russell 1000 Growth (R1G) and the Russell 2000 Growth (R2G) indexes continued to widen this past month. Over the last 10 years ending in April, the R1G appreciated 322% cumulatively and outperformed the R2G by 214%. This is a standout performance compared to previous decades. Over the decade ending April 2014, the R2G advanced 134%, beating out the R1G by a mere 18% cumulatively. During the large cap technology dominating decade ending April 2004, the R1G advanced 150%, beating the smaller index by a less significant 73%.
We believe the last decade of large cap dominance is not merely a difference in the anticipated impact of a higher interest rate environment. It is also being influenced by such factors as a preference for passive ETFs that favor large cap stocks, macro hedge funds that avoid illiquid small caps, and institutional demand for alternatives that are selling their small cap exposure to make room for larger private equity and venture capital allocations. There is one group that is beginning to take advantage of this disparity – corporations that seek to buy new products or services in a shorter time frame than they could accomplish through organic efforts. As can be seen in the chart below, such acquisitions are generally at a significant premium to the price the market has assigned them. The average premium from the list below is 80%, a nice premium, but in most cases below the level the acquiree was trading at three or more years ago. (Note: we currently own CoStar Group and sold Shockwave Medical after the acquisition announcement).
We believe that large corporations will continue to swallow up their smaller competitors, especially if the financial benefits are obvious. Over time, investors may notice, and this large differential between small and large capitalization companies may begin to narrow. We suspect that if interest rates begin to fall, maybe this trickle into smaller companies will likely become something more meaningful.
At Kingsland Investments, we believe that the value of small companies is being heavily discounted relative to past history for reasons that are not economic in nature. We think that in time, great businesses experiencing transformational growth will be discovered. By sticking to our process of buying and owning great young businesses, we think investors can benefit materially from these dynamics as they get discovered by either the market or a lucky corporate buyer.
All the best to you,
Arthur K. Weise, CFA