Whitney George: No News Would Be Good News for the Market

Whitney George

How would you characterize the current market?

For the last several months, we've been in a market characterized by more emotion than reason and driven by macro and political events. To me, the market is starting to look like a coiled spring. We don't know what might spring it loose, but investors are not likely to be held captive by low- or zero-interest alternatives for too much longer. In fact, I'm more and more convinced that we don't need good news for the market to go up—we only need relief from the onslaught of bad news.

In what sectors and industries were you most active during the highly volatile third quarter?

The downturn has been a macro- and liquidity-driven event, meaning that there has been no sector or industry that's gone unscathed. Our recent investments have been spread across the board pretty evenly, with a tendency toward reinvesting in those companies in which we have the highest conviction. To some degree, we've been using the playbook from late 2008-early 2009, which was really a "Back to Basics" theme that emphasized food, energy, and asset management, along with an ongoing interest in industrials and technology stocks. Outside of the U.S., we've been using the same themes, typically concentrating on developed countries. We've been spending a little more time looking at Europe than Asia recently. We moved from finding many opportunities in the wake of the natural disasters in Japan last spring to seeing opportunities more recently in Europe as issues over sovereign debt and the euro resurfaced.

Why is active small-cap management so important in the current environment?

There are two points in a market cycle when we think our style of active risk management is most important: when risk is widespread and when there is a perception that risk is at its highest, which is where I think we are now. Warren Buffett said it best—we think that active value managers need to be fearful when others are greedy and greedy when others are fearful. We're starting to feel pretty greedy as we look for attractively priced, financially strong companies that have the potential to come back strong when the market turns around.

How have both recent volatility and the larger flight from equities affected liquidity and valuations in small-cap stocks?

I think part of recent market volatility is a byproduct of less liquidity. Investors have been aggressively leaving stocks over the past five months, and this has created additional pressure to sell. In my experience, the cheaper something gets the less liquid it becomes. It's easier to match buyers and sellers when something is fairly priced or when prices are rising, but when prices are falling, at a certain point the seller loses interest in selling, and fewer people are interested in buying. I think we're seeing some of this in the small-cap market now. This isn't necessarily a negative, however. I see low liquidity as a good sign that stock prices have fallen well below their absolute valuations. Another confirmation of this is the high premiums being paid in M&A transactions. Over the last year or so, we've had holdings bought out at premiums as high as 50%. We've also seen a larger-than-usual number of companies buying back stock. And Warren Buffett recently said that his own company, Berkshire Hathaway, looked very cheap. Of course, the last time Buffett publicly declared that stock to be cheap was back in 2000, just before a long cycle of terrific returns for value stocks, so we'd love to see history repeat itself. In any case, limited liquidity is one of those short-term challenges that we try to turn to our long-term advantage. Right now, it appears to be symptomatic of a market close to bottoming out.

What will it take for the economy to grow more robustly?

I don't think it's reasonable to expect our economy to grow robustly until the necessary rebalancing takes place between those sectors that have been doing well and are globally competitive, such as agriculture and manufacturing, and those consumption-driven sectors that dominate our economy and have been struggling. I do think that the U.S. is well-positioned to benefit from growing global demand for industrial goods, technology, infrastructure improvements, and energy. The growth of the middle class in developing countries could be very good for our economy.