Arnold Schneider's Schneider Small Cap Value Fund 4th-Quarter Commentary

Discussion of markets and holdings

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Sydnee Gatewood
Jan 21, 2020
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Portfolio Objective

The Fund seeks long-term capital growth by investing primarily in common stocks of companies that have a market capitalization that are less than the largest company in the Russell 2000 Index and which Schneider Capital Management believes are undervalued.

Arnold C. Schneider III is primarily responsible for the day-to-day management of the Fund’s portfolio.

All investments contain risks and investors should consider the risks associated with investing in these types of Funds. Investments made in small capitalization companies are subject to a higher degree of market risk because they tend to be more volatile and less liquid when compared to larger more established companies.

Fourth quarter performance was well ahead of our index led by strong stock selection and overweighting in the cyclical sectors of the market which led in the quarter. Annual performance fell short of the indexes as our oil overweighting was punished severely. Energy was easily the worst segment of the market in a sharp disconnect from an over 30% yearly rise in oil prices. Our projected upside potential in our portfolio is still high relative to history as small cap value indexes continue to underperform growth and large cap. Small cap value is the only category with a P/E ratio that is below its 20 year average P/E ratio.


Non-shale global oil spending is down 40% from the 2014 peak. The last wave of long cycle new supply from that peak came in the fourth quarter from Norway. The second half of 2020 non-OPEC production should be roughly flat with the first half. 2021 long cycle new production additions will be approximately half of 2020’s level.

Irrational U.S. shale production growth in recent years has provided over 100% of global demand, but this is no longer viable at current long-term strip prices. Thus, yearly shale growth may continue to decelerate with a lag from the recent collapse in the rig count. Growth in production in 2020 is projected to roughly halve from recent levels of well over 1 million barrels/day. U.S. E&P based operators are finally committed to spending within cash flow and, more importantly, earning their cost of capital. Yearend multiyear strip prices below $55 are insufficient to earn their cost of capital. With the withdrawal of most of U.S. supply growth, global supply growth may not keep up with demand growth and OPEC will likely need to increase production starting in the seasonally stronger second half of 2020.

The U.S. consumer is in good shape, with a personal savings rate above average at 8%, rising wages and employment. Household debt service ratios are at 10%, well below the long term 12% average and are the lowest in 40 years. Rapidly rising net worth may help growth due to the wealth effect. Strong small business sentiment supports continued job growth. Finally, short term rates are not restrictive at a zero real rate.

On trade, greater certainty from the China compromise is positive for manufacturing. The gap between a strong service economy and a tepid manufacturing sector is historically wide, which is typically followed by a rebound in manufacturing. An inventory accumulation is likely after a long period of destocking. The strengthening of the Intellectual Property laws should also reduce Chinese theft from the U.S. The global monetary easing cycle should also help economic growth reaccelerate. Global leading economic indicators and manufacturing indexes are starting to improve which should boost small cap cyclicals which are selling at a record valuation discount to defensive sectors.

This update is being provided for informational purposes only. It is not intended as a recommendation or solicitation to purchase any security. Investors should consult with their Investment Professional about their particular investment program.

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