The year is off to a great start, as the S&P 500 has crossed 5,000 for the first time. This milestone, coupled with the fact that Fed policy has not negatively impacted markets or the broad economy, has been favorable for large-cap stocks. Given their relative insulation from elevated rates and the continued investor enthusiasm about artificial intelligence (AI), these stocks have been beneficiaries in the current market environment. A key question is what the catalyst for a sustained broadening of equity market participation will be, including better performance from mid and small-cap companies. This presents a promising opportunity for growth in the small-cap sector.
Our investment strategy encompasses a wide spectrum, from mega-cap “AI-related companies,” like Microsoft and Alphabet, to companies less overtly associated with the AI boom, such as Gartner Inc. in our small-cap portfolio. Gartner has experienced a significant surge in demand for its consulting services, aiding companies in optimizing AI investments. This underscores the pervasive influence of AI across sectors and the potential for even established companies to profit from this trend. In essence, our focus extends beyond the big tech players; we identify opportunities throughout the U.S. market and around the world.
The recent market environment has been favorable for certain sectors, like technology, which have seen strong gains. However, other areas, perhaps more closely tied to the health of the real economy, are facing headwinds from rising inflation and interest rates. Smaller companies are more vulnerable to higher interest rates. But, despite these challenges, small-cap companies still hold significant potential. Our model continues to identify high-quality companies with strong characteristics like earnings growth, pricing power, and a focus on innovation, indicating that there are still opportunities in this space.
Our approach prioritizes valuation and companies with predictable cash flows, offering both stability and significant upside potential. We favor companies with leading market positions with high barriers to entry. These companies are difficult to compete with, ensuring long-term success. We also look for strong fundamentals, such as earnings growth and pricing power. Our recent additions to the small-cap portfolio, such as NVE Corp and Helios Technologies, exemplify these characteristics. We believe these companies are well positioned to thrive despite current headwinds.
While currently overlooked, small-cap stocks can be a strategic addition to your portfolio. Their attractive valuations present a potential for significant long-term growth, especially as these companies mature. Furthermore, including small caps in your portfolio offers valuable diversification, reducing your overall risk and providing exposure to a different segment of the market with unique growth potential.
Finally, short-term, investment-grade bonds remain a compelling option for clients seeking to outpace cash returns while maintaining flexibility and principal preservation in this higher-rate environment. Because these bonds mature in three years or less, they offer reduced exposure to interest rate fluctuations, making them a more attractive option compared to longer-term bonds.
Thank you for your continued trust in Cardinal Capital. We remain committed to helping you achieve your financial goals. As always, we welcome your engagement and encourage you to reach out to us for a personalized portfolio review.
Best,
Cardinal Capital Management, Inc.