July 13, 2023
Dear Fellow Oberweis Funds Shareholder,
YEAR-TO-DATE PERFORMANCE THROUGH JUNE 30, 2023
There’s an old adage that the stock market climbs a wall of worry. The first half of 2023 appears to be a case in point. Despite persistent concerns of inflation and recession, global equity markets broadly rebounded. Both U.S. and international equities rallied materially, except for China, where equities fell 5.46%*. Globally, growth stocks outperformed value stocks, while large-cap stocks fared better than small. Continuing a phenomenal performance run relative to its benchmark and peers, the Micro-Cap Fund surged 18.55%, well ahead of the 7.16% gain of the Russell Micro-Cap Growth Index. The Small-Cap Fund returned 14.19% compared to 13.55% for the Russell 2000 Growth Index. The Emerging Markets Fund returned 10.96% versus 10.50% for the MSCI Emerging Markets Small-Cap Index. Rising U.S.-China tensions and an underwhelming post-Covid reopening in China were headwinds for the China Fund, which declined 8.96% compared to a 5.46% decline for the MSCI China Index. Among our developed market international funds, the Focused International Growth Fund returned 13.24% versus 11.67% for the MSCI EAFE Index, while the International Opportunities Fund gained 3.54% versus 5.72% for the MSCI World ex-US Small-Cap Growth Fund. The Global Opportunities Fund returned 8.22% compared to 8.02% for the MSCI AWCI Small-Cap Index.
*As measured by the MSCI China Index
MARKET ENVIRONMENT
The key issues for investors – inflation, recession, and Russia’s war on Ukraine – have not changed since last year. While the mainstream financial media spends a significant amount of time debating the merits and timing and magnitude of a supposed “impending recession,” most economists would admit that economics is an inexact science and predicting a recession is often a fool’s errand. As bottom-up stock pickers, we claim no edge in macroeconomic forecasting, as the associated data lies in clear view for all investors to see. Instead, we assess macro risks and influences on individual company fundamentals and discount those risks as we would any other.
What we see in the global economy is a mixed picture: there are plenty of positive and negative data points out there to substantiate one’s position (as behavioral finance folks, we call this “confirmation bias”). On the negative side, the Fed continues to raise rates and has signaled its intention for additional hikes later this year, and we know the impact of tighter monetary policy on the economy is historically lagged. The U.S. ISM Manufacturing Purchasing Managers’ Index (PMI) reading of 46 signals contraction, and the Eurozone reading of 43 is even worse. The resilient consumer – who drives 70% of the U.S. economy — has seen excess savings they accumulated during Covid dwindle just as student loan forgiveness is set to expire. They are also facing the worst housing affordability picture since 2008 as mortgage rates eclipse 7%. On the positive side, the Services PMI reading of 54 signals expansion, so that part of the U.S. economy remains resilient. Future earnings estimates point to growth as inflation is finally abating and corporate profit margins rebound. While the consumer is seeing savings shrink, they enjoy a record-low debt-service ratio and they still have jobs. Rising rates have yet to hit employment, which continues to surprise to the upside. Job openings are still near all-time highs and non-farm layoffs have yet to inflect upward.
What’s it all mean? We don’t profess to know. But here’s what we do know. First, we continue to find companies posting significant positive earnings surprises driven by misunderstood fundamental changes that should, based on our research, lead to additional earnings surprises in the future. These are idiosyncratic fundamental changes that tend to trump economic headwinds. Second, we know small-cap stocks are cheaper relative to large-cap stocks than they’ve been in more than 20 years. In fact, today’s relative valuation discount sits around two standard deviations, which means the current valuation delta between small-cap and large-cap stocks only happens around 5% of the time. Third, we know that non-U.S. stocks are much cheaper than their U.S. counterparts, especially in emerging markets. International equities have underperformed their U.S. brethren for a decade. Meanwhile, the U.S. large-cap market has been led by a narrow group of stocks trading at high valuations. The top 10 stocks in the capitalization-weighted S&P 500 Index comprise a record 32% of that index. Apple (AAPL) is now bigger in capitalization than the entire Russell 2000 and the top 5 market cap names are 3.5 times the market cap of small caps. Index investors unknowingly have a lot of eggs in a very small basket, and as a contrarian that set-up seems pretty compelling to us. We’d be surprised if small-caps didn’t outperform large-caps over the next decade. We also expect that, despite today’s uncertainties, international equities are likely to revert to more normal valuations over time.
In Europe, it is hard to find any strategist with much to say that’s positive. As European consumers have been deprived of cheap Russian natural gas, the cost of energy has sapped an ever-larger share of disposable income. That in turn has left the European consumer with less to spend, causing more pronounced economic slowness than in the U.S. That said, European stocks trade at a sharp discount to their American counterparts and trends, on the margin, appear to be improving. Energy prices in Europe are down year-over-year, which contributes to input price deflation and potentially higher margins. Much pessimism is already built into European stock prices, and the drags from input costs, inventories and capital spending appear to be marginally easing, which creates reasonable positive conditions for earnings surprises in the quarters to come.
Perhaps most difficult to forecast is China, where economic data has mostly been weak so far and unfriendly business policies have chased away many foreign investors. Again, this news isn’t new and Chinese equities are the among the cheapest in our investable universe. Relief for investors could come if the government commits to a new stimulus program. The worse the economic news, the greater the probability that the government will shift from a policy of deleveraging to stimulus, and it appears that pendulum has already begun to swing. When the Chinese government turns on the spending spigot against a backdrop of depressed stock prices, in our view you want to be in on the deal.
Emerging markets have generally been out of favor now for much of the past decade, in part due to the strength of the U.S. dollar, which hit its highest level of the last 20 years in the second quarter (Bloomberg Spot Dollar Index). Of course, that is not likely to last forever, and upswings in emerging markets tend to be swift and strong. So far into the third quarter, the dollar has already declined well off that high. A weakening dollar paired with below-average valuations could be good news for investors in the Emerging Markets Fund. I’m also pleased to wish the Emerging Markets Fund a Happy Fifth Birthday, with a track record boasting an average annual return of over 200 bps ahead of its benchmark since inception.
While sentiment may swing wildly in the short-run in response to incremental economic data, comments by the Federal Reserve, headlines, and TV soundbites, our bottom-up investment strategy focuses instead on companies demonstrating better-than-expected earnings power driven by transformational change. The P/E multiples afforded such companies may vary from quarter to quarter based on investor risk appetite, but we believe that the ultimate valuations of such companies will be driven by their ability to innovate, create new products, take market share, and generate cash flow back to shareholders. Times like today, when valuations for such companies are very reasonable amid uncertain economic times, have been historically favorable for investors in our strategies.
VALUATION RECAP
As of June 30, 2023, the weighted-average forward price/earnings (P/E) ratio was 14.9 times for the Global Opportunities Fund (versus 15.0 last quarter), 19.3 times for the Small-Cap Opportunities Fund (versus 15.3 last quarter), 15.4 times for the Micro-Cap Fund (versus 13.2 last quarter), 17.8 times for the International Opportunities Fund (versus 15.5 last quarter), 14.4 times for the China Opportunities Fund (versus 18.6 last quarter), 20.5 times for the Emerging Markets Fund (versus 19.1 times last quarter), and 16.7 times for the Focused International Growth Fund (versus 14.2 last quarter). Each of these funds invests in companies with expected earnings growth rates that are higher than that of the broader market, and in companies expected to grow faster than current market expectations. It’s worth noting that the P/E ratio of the funds with significant non-US exposure (the International Opportunities, China Opportunities, Emerging Markets, and Global Opportunities Funds) remain well below their historical average P/Es. As of June 30, 2023, the weighted-average market capitalization was $4.3 billion for the Global Opportunities Fund, $4.7 billion for the Small-Cap Opportunities Fund, $1.6 billion for the Micro-Cap Fund, $5.9 billion for the International Opportunities Fund, $58.4 billion for the China Opportunities Fund, $3.4 billion for the Emerging Markets Fund, and $132.5 billion for the Focused International Growth Fund.
Thank you for investing with us in The Oberweis Funds.
Sincerely,
James W. Oberweis, CFA
President & Portfolio Manager
For current performance information, please visit www.oberweisfunds.com.
Performance data shown represents past performance and is no guarantee of future results. Investment return and principal value will fluctuate, so that you may have gain or loss when shares are sold. Current performance may be higher or lower than quoted. Unusually high returns may not be sustainable. Visit us online at oberweisfunds.com for most recent month-end performance.
The Oberweis Funds invest in rapidly growing smaller and medium sized companies which may offer greater return potential. However, these investments often involve greater risks and volatility. Foreign investments involve greater risks than U.S investments, including political and economic risks and the risk of currency fluctuations. There is no guarantee that the funds can achieve their objectives. Holdings in the Funds are subject to change.
Before investing, consider the fund’s investment objectives, risks, charges, and expenses. To obtain a copy of the prospectus or summary prospectus containing this and other information please visit our website at oberweisfunds.com or call 800-323-6166. Read it carefully before investing. The Oberweis Funds are distributed by Oberweis Securities, Inc. Member: FINRA & SIPC.
1Institutional Class shares OBGIX, OMCIX, OBSIX and OCHIX performance information was calculated using the historical performance of Investor Class shares for periods prior to May 1, 2017.
2Life of Fund returns are from commencement of operations on 01/07/87 for the Global Opportunities Fund, 01/01/96 for the Micro-Cap Fund, 09/15/96 for the Small-Cap Opportunities Fund, 10/01/05 for the China Opportunities Fund, 02/01/07 for the International Opportunities Fund, 05/01/17 for the Institutional Share Classes, 05/01/18 for the Emerging Markets Fund Share Classes and 04/01/22 for the Focused International Growth Fund.
3December 31, 2022 data. Expense ratio is the total net annualized fund operating expense ratio. The expense ratio gross of expense offset arrangements and expense reimbursements was 1.52%, 1.28%, 1.53%, 1.27%, 1.45%, 1.20%, 2.05%, 1.80%, 1.87%, 2.90%, 2.65% and 1.97% for OBEGX, OBGIX, OBMCX, OMCIX, OBSOX, OBSIX, OBCHX, OCHIX, OBIOX, OBEMX, OIEMX and OFIGX respectively. Oberweis Asset Management, Inc. (OAM), the Fund’s investment advisor is contractually obligated through April 30, 2024 to reduce its management fees or reimburse OBEGX and OBMCX to the extent that total ordinary operating expenses, as defined, exceed in any one year the following amounts expressed as a percentage of each Fund’s average daily net assets: 1.8% of the first $50 million; plus 1.6% of average daily net assets in excess of $50 million and for OBGIX and OMCIX 1.55% of the first $50 million; plus 1.35% of average daily net assets in excess of $50 million. OAM is also contractually obligated through April 30, 2024 to reduce its management fees or reimburse OBSOX, OBCHX, OBIOX, OBEMX and OFIGX to the extent that total ordinary operating expenses exceed in any one year 1.25%, 2.24%, 1.60%,1.75% and 0.95% expressed as a percentage of each Fund’s average daily net assets, respectively, and for OBSIX, OCHIX and OIEMX 1.00%,1.99% and1.50% respectively. Effective May 15, 2023, for OBCHX, OCHIX, OBIOX, OBIIX, OBEMX, OIEMX and OFIGX, respectively, the adviser may recoup the amount of any expenses reimbursed under the contract within three years following the date of the reimbursement if the recoupment does not cause the Fund’s expenses to exceed the expense limitation in place at the time of the recoupment, or the expense limitation in effect at the time of the initial reimbursement, whichever is lower.
The MSCI World ex-US Small Cap Growth Index (Net) is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of small cap growth developed markets excluding the US, with minimum dividends reinvested net of withholding tax. The MSCI ACWI Small Cap Index (Net) is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of small cap developed and emerging markets with dividends reinvested net of withholding tax. The MSCI Emerging Markets Small Cap Index is a free float-adjusted, market capitalization-weighted index that measures the performance of small-cap stocks in 24 emerging markets. The MSCI China Net Index is a free float-adjusted market capitalization-weighted Index of Chinese equities that include China-affiliated corporations and H shares listed on the Hong Kong Exchange, and B shares listed on the Shanghai and Shenzhen exchanges and P chips and foreign listings with minimum dividends reinvested net of withholding tax. The MSCI EAFE Index is an equity index that captures large and mid-cap representation across 21 developed markets countries around the world, excluding the U.S. and Canada. The index is comprehensive, covering approximately 85% of the free-float-adjusted market capitalization in each country.
The Russell 2000 Index measures the performance of approximately 2,000 companies with small-market capitalizations. The Russell 2000 Growth Index measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted earnings growth rates. The Russell Microcap Growth Index measures the performance of those Russell Micro Cap companies with higher price-to-book ratios and higher forecasted growth values. The performance data includes reinvested dividends. The Russell Microcap Index is represented by the smallest 1,000 securities in the small cap Russell 2000 Index plus the next 1,000 securities. Each index is an unmanaged group of stocks, whose performance does not reflect the deduction of fees, expenses or taxes.
