Arnold Schneider's Schneider Small Cap Value Fund 3rd-Quarter Commentary

Discussion of markets and holdings

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Sydnee Gatewood
Oct 17, 2019
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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.

Our energy exposure was the main cause of our underperformance versus our index in the quarter. Oil prices fell modestly during the period on slightly slower demand growth from weaker international economies. Since early 2016, oil prices have more than doubled, but energy related equity indexes have barely moved in the same time period. Deep value factor headwinds continued as the quarter’s value winners were led by bond proxies (utility stocks and real estate investment trusts), low volatility equities and perceived high quality.

We buy stocks when current pessimism is high, but where we see potential for much higher earnings in the future. These are controversial stocks. High earnings estimate dispersion companies currently sell at half of their average long term relative p/e (price/earnings). We believe cyclical stocks are currently fully discounting a potential recession. However, cyclicals historically outperform through actual recessions. The desire for certainty is coming at a very high price.


With OPEC production down sequentially in the third quarter, global inventories should decline in the fourth quarter. The various summer Iranian attacks show the potential for price spikes given the low level of spare capacity.

Massive cutbacks in exploration spending in the last few years has led to new conventional discoveries in the last 3 years being the lowest in 70 years. Additionally, the 20% drop in the U.S. oil rig count from the peak last November is leading to sharply decelerating U.S. production growth. Fundamentally, the industry does not earn its cost of capital with WTI prices in the low 50s and cannot sustain itself at the current price level. Exploration and Production companies sell at roughly half the enterprise value to EBITDA (earnings before interest taxes depreciation and amortization) multiple of the S&P 500, the widest gap since the internet bubble of 2000.

China’s economy continues to slow. In response, their fiscal and monetary stimulus is being expanded. This sluggishness has dragged down Germany’s massive export sector impacting Europe as a whole. While international growth is weak, there is still an output gap overseas leaving room for economic expansion. There have been numerous global manufacturing downturns since 2008, but all have been resolved by policy stimulus. Will this time be different?

While international manufacturing is at a standstill, manufacturing is approximately 10% of U.S. GDP compared to consumption which is roughly 75% of GDP. The strong U.S. consumer is seeing rising wage growth of over 3% with a high savings rate. With the Federal Reserve cutting rates, the consumer should remain sturdy. Our portfolio is wildly out of favor, but we believe it is a coiled spring. We believe that when the global manufacturing slowdown ends, the rotation from unusually expensive low volatility stocks to unusually cheap deep value stocks could be significant.

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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