Introduction Is the market finally correcting the recent excesses of stock valuations, particularly in the small-mid-cap area? The admittedly arbitrary definition of a stock market correction is when an index declines 10% or more from its recent level. Based on this, the Russell 2000 (R2000) recently fell into correction territory while the S&P 500 has declined 9% over the past month (as of 10/14/14). Moreover, the Russell Microcap Index is down more than 17% from its high earlier this year, with microcap technology stocks down nearly 25% since March. Thus, small-cap stock valuations, relative to large-cap valuations, are in the process of reverting back toward historical averages. In some ways, the smaller decline in the S&P 500 has masked the broader correction for a number of industry sectors. Besides those mentioned above, large-cap automotive stocks are down 18% since July, and energy stocks are also getting hit with the S&P Oil & Gas Exploration & Production index down 25% since this past summer. While your portfolio is not immune to this correction, we believe the companies we own have strong balance sheets, providing management teams an ability to take advantage of any good opportunities to buy assets on the cheap – should any opportunities present themselves. We have managed this strategy through a number of corrections and each time, while we take temporary hits to capital, we have been able to take advantage of opportunities that present themselves during these periods of dislocation. Our strategy’s three-decades of history shows that we can deploy capital very rapidly when valuations are depressed and when fear and uncertainty are high. On the other hand, we have exhibited tremendous patience in holding higher than normal levels of liquidity when valuations are rich. The last couple of years tested our patience, but we were fortunate to have discovered stocks that still met our stringent investment criteria and deployed some of your capital into these new investment opportunities. In recent weeks we deployed incremental capital as selling pressure accelerated. If the current volatility continues, we fully expect that we will be more aggressive in deploying your capital as valuations become even more attractive.
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