Fear returned to the market in a big way in the first quarter. And for selective, long-term value investors like us, this was welcome news.
Whether or not bank failures in March wind up sparking a full-fledged financial crisis, one thing seems clear: A year into the Federal Reserves’ tightening cycle, rising rates are putting balance sheets under pressure, leading to tighter lending standard, widening credit spreads, and a growing perception of risk.
Those concerns will weigh on the markets in the near term. Yet other developments bode well for the long term. For instance, common sense seems to be returning to the market. As recently as late January, only 7% of U.S. chief executives surveyed by The Conference Board said they were preparing for a deep recession. That’s likely to change, amid growing fears over the stability of the banking system.
And in a world of lending and liquidity concerns, fundamentals matter again, as investors are now demanding evidence of financial strength in the aftermath of the recent collapse of Silicon Valley Bank, Signature Bank, and Silvergate Capital. For value investors looking to own well-run businesses at reasonable prices, this is a heartening turn — despite the rising risks.
Risk, of course, isn’t just a reflection of external forces like rising rates and widening credit spreads. It is also a function of what investors know — or more to the point, don’t know — about the companies they own, as Warren Buffett famously noted. At a time when financial, market, and economic risks are all on the rise, minimizing investor risk by knowing what you own is more critical than ever.
At Heartland, having strict standards and maintaining discipline is ingrained in our 10 Principles of Value Investing™, which demands that we focus on compelling valuations, balance sheet strength, and sound business strategies. We also prefer companies with positive earnings dynamics, and profitability is particularly important in volatile times. Given that the percentage of non-earners in the small-cap benchmark remains at uncomfortable levels, this is a time for active value investors to focus on disciplined selectivity.