Chuck Royce and Francis Gannon detail where they are finding small-cap opportunities amid negative economic news.
Q2 hedge fund letters, conference, scoops etc
Francis Gannon: Chuck, we had an interesting second quarter driven by a lot of macro noise with also a lot of volatility. What are your thoughts on the quarter?
Chuck Royce: I liked the quarter for a lot of reasons, primarily because we had real volatility. April was straight up, May was straight down, June was straight up. And that is a shift from the more linear progress we’ve had in other years. Volatility is very healthy for us as an active manager, so I think it’s a very positive environment.
FG: So the other aspect in the quarter was the yield curve, which did invert for a period of time during the quarter, and many people are focusing on the predictive aspect of that, predicting the next recession sometime off in the future. How do you think about the yield curve at this particular moment in time?
CR: First place, the idea that it predicts a recession is sure, and some say there’s always going to be a recession. You can always say something predicts something. It’s the timeframe that matters, not whether there will be a recession. Of course, there will be a recession. I personally do not think we’re in the mode coming up soon to a recession at all, as technically defined. So I think we’re having a slowdown of growth, and that’s what sort of confusing the headlines.
FG: The collapse in the 10-year that we saw in the latter part of the second quarter I think has been widely written about in terms of its effect on the overall market. What are your thoughts about the yield on the 10-year coming down so dramatically at the end of the quarter?
CR: It’s what’s happening in the inflation world. Inflation has not been on target. The Fed’s target is 2% plus. We have not hit that target in a long time, and I think as the market has picked up on that inflation has come down, therefore rates are coming down.
FG: When you talk with the management teams, are you hearing any company talk about a potential recession on the horizon?
CR: Not really. They all are conscious of rate of growth. They’re all conscious about okay, they’re all setting their ‘19-‘20 estimates right now. They’re going to start drifting into the sort of public conversation and they’re all being cautious but positive.
FG: What are companies saying about all of the tariff issues that seem to be front page every day?
CR: I had a very interesting conversation yesterday with a company that was emphasizing that there’s nothing new in tariffs at all. Tariffs have been a fact of life forever. And that he was saying that they had been planning substantially for tariffs as, as they have evolved. And it is basically part of their conversation with their customers at all times. So they, they initiate those conversations and pass these costs along.
FG: So better companies know how to deal with something like this is what you’re saying?
CR: It’s just another cost factor.
FG: Tell us about cash in your portfolios. It did go up during the quarter.
CR: I think our cash is going up for normal reasons. We’re not macro betters. I like to think those are sort of after-hour feelings and I don’t apply them to the portfolio by and large. Our portfolios are built from the bottom up, and that’s the way I think portfolios should be run.
FG: One of the more interesting aspects about the quarter is that even with all of the tension from tariffs and potential slowdowns on a global basis, cyclical areas in the market actually did better than many people thought, even after May when all you saw were the defensive areas of the market doing extremely well. Where are your thoughts now on this cyclical aspect of the companies that you hold?
CR: We still believe that high-quality, cyclical companies will do very well in the years ahead. They haven’t had their moment in the sun yet, and so we believe they represent great value.
This transcript has been edited for clarity.
Article by The Royce Funds
