MEMORANDUM

As we know, in recent days, the global stock markets have been rocked by a complete re-writing of U.S. trade policy with the Trump Administration’s intention to apply across-the-board tariffs to every country that buys and sells American goods. Wolfe Research reported that “this policy represents the largest tariff increase since 1930 with significant economic implications.” Political parties aside, the commonly shared economic view is the hefty up charges are de facto taxes on businesses and consumers that are detrimental to U.S. and global growth. The market’s abrupt and rapid decline underscores this consensus as well as a growing fear that a global recession may already be at hand. Even if one believes that trade imbalances are problematic, and even with yesterday’s 90-day “pause,” the approach has incited panic, rumor, gossip and for now, a great deal of uncertainty. The escalating “tit for tat” with China only ups the ante.

Our analysis suggests the market is responding to three distinct yet interrelated concerns. First, higher input costs across global supply chains. Second, rising inflation against a backdrop of slowing growth. Third, a market re-setting from soaring expectations, to one that will predictably over-correct in reaction to the unsettled state of the world.

So, what are we doing at Ariel?

We start by controlling what we can control. We cannot control tariff policies or global trade negotiations, but we can control our own responses. To that end, in times like these, we are measured, deliberate and actively patient—willing to take advantage of today’s volatility with an eye towards longer-term gains.

We begin by reviewing every stock in our portfolios with a goal of re-underwriting our investment thesis on our current holdings. Rarely do we sell into the mayhem, but in the event of a newly “broken” investment thesis, we will re-deploy assets to better opportunities. More often, we accumulate additional shares of our most downtrodden names that have been oversold in a rush to judgment. Simultaneously, we are also sifting through the wreckage—evaluating stocks that have sat on our “wish list” as we have awaited a more favorable entry price. Because of our deep knowledge of our investment universes, we can move fast and with conviction. And in this case, unlike the complete unknown of the recent Covid crisis, we can reasonably model for tariff scenarios.

In terms of specific decisions, the domestic, global and emerging markets teams are acting as follows: 

Domestic Equity Team

We are rigorously vetting all strategies by:

• Scrutinizing our portfolio for companies demonstrating resilient pricing power amid inflationary pressures.
• Conducting comprehensive supply chain vulnerability assessments across existing holdings and prospective investments.
• Identifying instances where negative market sentiment has created valuation disconnects that present strategic entry points.
• Maintaining our unwavering commitment to businesses with capital structures designed to withstand macroeconomic uncertainty.
• Selectively deploying capital where our conviction in long-term business fundamentals stands in stark contrast to short-term market reactions.

We expect market volatility to likely remain heightened. That said, our current pro-cyclical positioning reflects our bottom-up conviction in specific business values rather than macroeconomic prognostication. If there is any silver lining to this challenging time, it is that high-quality stocks that rarely go on sale are being served up. To this point, we have been adding to consumer discretionary names that have been over-sold in reaction to recessionary fears and selling consumer staples that have held up better but trade at less compelling valuations. The companies in our portfolios are selected for their ability to compound intrinsic value over complete economic cycles—precisely the environment we now face.

Global and Emerging Markets Team

As we consider risks and opportunities around the globe, we are doing the following:

• Watching the largest U.S. stocks which have declined—but still not enough relative to valuations elsewhere.
• Maintaining our current level of defensiveness with a continued tilt towards stocks that will be more insulated from market decreases.
• Reviewing dislocated names with a focus on company-specific upsides while holding our current weighting in economically sensitive names.
• Re-underwriting and stress testing individual companies that could most be impacted by geopolitical risks as well as the microeconomic risks of cap-ex pressures, rising costs, etc.

In recent days, we have taken additional steps to further protect our portfolios in the current environment. In periods of high economic uncertainty, financial names become more volatile and vulnerable given their levered balance sheets require continuous refinancing. Since April 3^rd, we have reduced our financial sector weighting in our global portfolios by roughly 8 percentage points. The proceeds have been re-deployed across current holdings as well as some new names. Our purchases reflect company-specific opportunities in defensive and cyclical sectors. While the odds of slower economic growth in the U.S. and globally have increased, this portfolio shift was not driven to suit a revised economic outlook but rather to get ahead of hampered access to liquidity. The magnitude of this shift in a short period is unusual for us. We are long term investors, but when there is a significant change in the risk environment, we seek to be proactive, particularly in such a weighty sector like financials. Similar to the domestic team, we will remain opportunistic in a volatile environment.

In Sum

There is a chance the tariffs could be constitutionally challenged. Whatever the outcome, we remain confident in our disciplined methodology of identifying differentiated businesses with strong cash flows, significant competitive barriers and compelling valuations that provide a substantial margin of safety.¹  While we cannot predict the future, we do consider reactionary market pricing against long-term fundamental outlooks and take advantage of our ability to be more patient than the average market participant. Our 42-year history is littered with gut check moments that ultimately provide the wherewithal and resilience needed to confront the next predicament. Certainly, the short term may be uncomfortable, but we remain convinced that no matter how difficult things may be, storms always pass.

¹ Attempting to purchase a stock with a margin of safety does not protect investors from the loss of their investment, volatility associated with stocks, declining fundamentals, external forces, or our incorrect assumptions.