As an active investment manager, we are constantly monitoring and re-evaluating our holdings to make sure that they continue to track our investment strategies, and help our clients receive the best results possible.
Today, we’re touching on three different sectors of the market through the lens of our investment approach.
The technology sector has been dominating this year, in fact it was the driver behind the market rally as a group of eight companies drove performance. The Nasdaq Composite, the tech-centric index, had its best first half of a year in four decades. Fueled by the excitement about artificial intelligence (AI), are tech companies ushering into a new computing era? Maybe- but the market hasn’t discriminated enough between who the real AI beneficiaries are and who may just be riding the coattails of today’s hottest narrative. We are avoiding the noise and focusing on fundamentals.
Generative Artificial Intelligence (AI)
Across the technology sector, there are a variety of AI opportunities to tap into. With AI providers ranging from large cloud companies, large internet companies, semiconductors and data centers – companies can leverage AI to grow revenues and reduce their costs. Companies have the potential to implement AI through software as a service (SaaS), video games, payments, ecommerce, and more. The growth of AI within the technology sector and beyond has the potential to expand revenues and tap into new markets.
Has the Market Gotten Ahead of Itself?
You don’t have to be a programmer or a tech whiz to benefit from AI. AI is one of the more salient technologies from a consumer perspective. While we see potential, it's important to understand that AI is not necessarily new. AI has been around since the 1950s, and we have seen various AI winners max out. Over the years, roadblocks and other issues with these platforms have surfaced, so keeping that in mind alongside the current hype around AI, we need to be realistic about how this innovation will evolve in the industry. Today, we are monitoring a number of companies that are trading at valuations that range from not compelling to downright expensive. We are keen to use our valuation disciplines to avoid parts of the market where the risk-reward is not compelling.
Banks are a cyclical industry that, today, is caught in the crosshairs of changes in monetary policy, a macroeconomic slowdown, and increased regulation following the collapse of SVB in March of 2023.
High Interest Rates Pressuring Balance Sheets
So far through 2023, there has been a series of regional bank failures. Banks are getting hit hard on both sides of the balance sheet. When interest rates were low, banks acquired considerable stocks of treasury bonds in their portfolios at low interest rates. Since that point, the Fed has increased rates, ultimately creating losses on those portfolios. Unfortunately, demands for liquidity has forced many banks to realize those losses. At the same time, banks are increasing lending standards and issuing fewer loans in anticipation of potential economic weakness. The liability side of the balance sheet has been impacted by deposit outflows from real competition, which created higher yields in items, such as short-dated treasuries. All the while, the regulatory environment is worsening. This has created an extremely challenging environment for banks.
Recessions Lead to Loan Losses
The areas we are seeing the most concerns for banks are areas that we believe will worsen through a recession. Loan portfolios turning for the worse, delinquencies picking up, and commercial real estate risks, will continue to put pressure on banks, which may result in poor earnings, consolidation, or even failure in extreme scenarios.
As we move through the economic cycle, we will lean on our time-tested investment strategy with banks, and work on preparing individual names through our bottom-up process. Currently, bank valuations are moving in the right direction, however we believe their fundamentals are deteriorating. With fundamentals in question, we could see more panic within the sector, also resulting in potential bank failures or consolidations. If this story plays out, you can expect us to look for opportunities to own the strong survivors.
Lastly, when we look at the housing sector, we are seeing sectoral tailwinds while also being stuck in the headwinds of the Fed’s tightening cycle.
Housing Supply is in Shortage
The housing market stands out because it has been hit by the Fed’s interest rate hike campaign, but it has also provided opportunities.
Power tool makers and distributors of home improvement supplies are two examples. These types of companies are currently under pressure, but we are confident will come out of the recession on the other side. We have been focusing on identifying well-positioned companies with strong competitive advantages that we believe traded down to attractive valuations.
At this time, we have seen an increase in demand for new home construction, which is presenting a different downturn within the market. We believe this downturn will be relatively short since there is a lack of consistency in building supplies and labor available to support this demand.
Opportunities Caused by the Current High Mortgage Rates
Due to the increase in mortgage rates today, housing affordability has been crushed. Consumers are hesitant to put their homes on the market in fear of starting a new mortgage at these high rates.
Today, we are seeing many companies that have exposure to the housing market undervalued, in part we believe caused by the increased mortgage rates. As active investors we see this pain as an opportunity. When the sector is under pressure and undervalued, we will be able to step in and buy these companies at discounted prices. This allows us to increase our share and be well positioned in our portfolios for their upturn.
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This material contains the opinions of Manning & Napier Advisors, LLC, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.