Small Cap Fund

(As of 12/31/22) — Capital markets rallied modestly in the 4th quarter as the S&P 500 Index gained 7.56%, the only positive quarter for 2022. Cooler inflation readings, resilient consumer spending, and better-than-expected corporate earnings buoyed markets during the first two months of the 4th quarter before pulling back in December. Much of the focus remains on the path of future interest rates, recession fears, and the economic and market impact those events may generate in 2023.

Despite the 4th quarter advance, the stock market recorded its worst calendar year since 2008, with a decline of -18.11% for the S&P 500 Index, and a loss of -32.54% for the growth-oriented and technology-heavy Nasdaq Composite Index. Large cap technology stocks and the more interest-rate sensitive assets suffered the most, while value stocks outperformed. In the end, nine of the S&P 500 Index’s 11 economic sectors declined. Energy stocks were the bright spot, recording a gain of 65.72% for the sector while Utilities eked out a gain of 1.57% in 2022.

The damage wasn’t isolated to the stock market as the investment-grade bond indices suffered double-digit losses for the year as well. In fact, a traditional balanced investment portfolio of 60% stocks and 40% bonds suffered the 4th worst drawdown in the past 100 years.

Recapping quarterly results, the broad-based Russell 3000 Index advanced 7.18% in the period. Value stocks significantly outperformed growth stocks to close out 2022, as the Russell 3000 Value Index returned 12.18% versus a return of just 2.31% for the Russell 3000 Growth Index. Relative performance was mixed going down in market cap size as small caps advanced less than large caps in the quarter, while mid cap stocks outperformed both large and small caps. Larger cap stocks returned 7.24%, as measured by the Russell 1000 Index, compared to the smaller cap Russell 2000 Index return of 6.23%, while the Russell Midcap Index produced a return of 9.18% in the quarter.

(As of 12/31/22) — The direction of the market overall will likely continue to depend on inflation’s trajectory and the amount of economic damage caused by higher interest rates. The inflation picture continues to ebb and flow. While we are seeing a decline in logistics costs, shipping rates, and some commodity prices, component shortages continue to persist. Generally, it seems price increases are moderating but the sustainability of this moderation is questionable.

While the Federal Reserve has already increased interest rates by 425 basis points, market expectations forecast another 50 to 75 basis point increase in this tightening cycle. In response, there has been a growing chorus for the Federal Reserve to slow its pace of tightening and allow previous hikes to make their way through the economy. Meanwhile, global economies continue to slow, especially in Europe where energy prices remain high. While many companies have already lowered financial guidance for the year, we could be in store for another earnings season of decreasing estimates which may possibly bring more market volatility.

Throughout 2022, small cap stocks re-rated for the prospect of a significant slowdown in economic growth in 2023. As a result, we are taking advantage of stocks that are oversold by our analysis. At the same time, we are being cautious with unfamiliar management teams and their ability to navigate a less predictable economy and market volatility. Portfolio positioning is fairly defensive within Technology, with a focus on a steadier IT Services industry and the Communications Equipment industry, which has unique demand drivers due to government subsidies.

The portfolio continues to be underweight Semiconductors and Software relative to the benchmark. We’ve added slightly to Energy sector exposure with higher quality energy-related companies, but the portfolio remains underweight relative to the benchmark. Larger positions within the Fund continue to be companies with recurring revenue streams, or those with strong demand and good visibility into future earnings.

As always, we believe all of our investments could benefit from long-term growth trends and trade at attractive valuations – the cornerstone of our investment process. We thank you for your continued support.