MACRO OBSERVATIONS
- The broadening of the equity markets is good for small cap stocks and something we have been expecting as inflation cools and the expectation of a rate cut is closer on the horizon.
- Money flows into the small cap asset class have improved. It does not take much investor demand to move small cap stock prices based upon the limited liquidity versus larger cap stocks.
- The next few quarters should allow the economy to continue digesting the impact of higher interest rates. Global economic growth should remain slow as the impact of the higher cost of capital filters throughout the economy. We do not expect a significant recession, and we believe we are closer to the end of the economic slowdown.
- Corporate layoffs continue as management teams prepare for the possibility of a weaker economy and slower business opportunities. A higher unemployment landscape would benefit the argument for rate cuts.
- Companies continue to adjust inventory levels to meet end-markets’ lower demand and higher cost of capital to retain inventory levels. We expect inventory levels to stabilize over the remainder of 2024, leading to a more balanced supply and demand relationship into 2025.
- Unfortunately, geopolitical risks escalated, and we expect these risks to persist for an extended period. The U.S. political environment will also add volatility and uncertainty as investors begin gauging election outcomes in November.
- The Russell 3000 provides exposure to the largest 3,000 U.S.-listed companies. Effective June 30, mutual funds are required by the SEC to issue Tailored Shareholder Reports (TSR). As part of the TSR, funds must compare themselves to a broad-based market index. Needham chose the Russell 3000, which includes the largest 3,000 investable U.S. equities. We note the ten largest companies total about 1/3 of the index and include Microsoft Corp. (MSFT), Apple Inc. (AAPL), NVIDIA Corp. (NVDA), Alphabet Inc. (GOOGL), Amazon.com Inc. (AMZN) and Meta Platforms Inc. (META).
IMPACTS ON PORTFOLIO PERFORMANCE
- The Fund’s Institutional (NESIX) and Retail classes (NESGX) returned 5.44% and 5.25%, respectively, in the second quarter, compared to the Russell 2000 Growth’s -2.92% and the Russell 3000’s 3.22%.
- The Fund deployed the majority of its cash position at the end of 1Q24 and it benefitted the Fund throughout 2Q24 as small cap companies enjoyed the expanded breadth in the markets. We are excited for the quarters ahead as small caps continue to gain traction and attention from investors. We ended the quarter with an 9.0% cash position and will look for opportunities to deploy cash during earnings season.
- We believe there is significant value within the asset class after years of selling pressure and investor avoidance. We look forward to the second half of 2024 as management teams continue to focus on improving cost structures and margins, accelerating revenue, and strengthening balance sheets.
- The Fund’s top five performers in 2Q24 were: Aspen Aerogels, Inc. (ASPN), TTM Technologies, Inc. (TTMI), FormFactor, Inc. (FORM), Veeco Instruments, Inc. (VECO) and SiTime Corp. (SITM).
- The Fund’s top five detractors on 2Q24 were: AXT, Inc (AXTI), nLight, Inc. (LASR), CryoPort, Inc. (CRYX), Cambium Networks Corp. (CMBM) and Vicor Corp. (VICR).
OUTLOOK
- Higher interest rates and inflation will continue to impact economic activity as companies focus on their balance sheets and accumulate cash. Investments in innovation will be delayed and impact the recovery of supply chains. Higher interest rates may cause further stress within the economy as real interest rates increase and inflation decreases.
- Capital markets will remain challenged although we expect capital markets to show signs of recovery as the expectation of lower Fed Funds rates is more visible.
- We expect a more favorable M&A environment and a potentially less confrontational approval process if there is a political party change in the White House.
- Technology remains a long-term strength of the economy, and several major secular trends persist firmly in place to support continued growth. Areas of long-term investment that we continue to like are data centers, mobile electrification, communications infrastructure, defense, AI, cloud computing, wireless connectivity, software and security, and specialty material manufacturers. Innovation within our portfolio companies continues and long term, we believe these investments will benefit the Fund.