CIO Mid-year Outlook: "Punctuated Equilibrium"

In his mid-year outlook, Hennessy Funds’ CIO Ryan Kelley reflects on the past year and shares his thoughts for the future.  

June 2021
  • Ryan C. Kelley
    Ryan C. Kelley, CFA
    Chief Investment Officer and Portfolio Manager

I can hardly believe that we have been navigating through one of the worst pandemics in modern history for more than a year. From the start, our thoughts have been with those affected by COVID-19 and with our frontline healthcare and essential workers. We are encouraged by the rapid rollout of vaccines and the continued reopening of the economy, and we hope this signals a turning point.

This is the first time in over 20 years in this business that I have witnessed volatility as extreme as the volatility that has rocked the financial markets and the economy over the past year. Both the pace of change and the magnitude of change have been staggering. As I reflect on this, I am reminded of a scientific concept called “punctuated equilibrium.” Biologist Stephen Jay Gould revolutionized evolutionary thinking with this theory, which challenged the prevailing belief that biological change happens slowly, consistently, and methodically over time. His theory instead proposed that change happens abruptly and dramatically and that new species pop
up and others vanish rapidly, sometimes caused by catastrophic events. In between these explosive periods are much longer intervals of relative stability.

The dramatic market downdraft brought on by the pandemic, followed by the equally dramatic recovery, have been jarring. We witnessed an explosion of IPOs, a plethora of bankruptcies, and a dramatic change in market leadership. Yet unlike in the biological world, we are able to respond to stock market crises and try to dampen their negative impact. There have been numerous and unprecedented fiscal and monetary responses from the Federal Reserve and the U.S. government, and in many ways these measures may have spurred the economic recovery. 

For the first six months of our fiscal year through April 30, 2021, the market appeared to be on a relentless march higher, with the S&P 500® Index rising 28.85% on a total return basis, setting new all-time highs 35 times in 124 trading days and closing at its then highest level ever on April 29, 2021. We saw a dramatic shift back toward value investing, and many of the sectors and individual stocks that had underperformed for most of last year soared. Value outperformed growth, small-caps beat mid caps, and mid caps beat large-caps. The Energy and Financials sectors skyrocketed, as evidenced by the S&P 500® Energy Index’s total return of 75.94% and the Russell 1000® Index Financials’ total return of 53.41% during the six-month period. As we begin to move beyond the chaos caused by the pandemic, solid market fundamentals are reappearing, which we believe underscores the health and strength of our economy.

We are pleased with the performance of our mutual funds during the first half of our fiscal year. On an absolute basis, each of our 16 Funds achieved positive performance, and 11 of our 16 Funds outperformed their primary benchmark. Ten of our 11 domestic equity-only Funds outperformed the S&P 500® Index, and three of our sector Funds posted total returns of over 50%, due primarily to their focus on the Energy and Financials sectors. We believe this was a favorable period for both our style of high-conviction investing as well as the areas and sectors of the market in which our Funds focus. While performance may wax and wane over a complete market cycle, we remain committed to managing our portfolios for long-term performance, ever mindful of downside risk. 

Circling back to Gould’s theory of punctuated equilibrium, we are left with the question, “Where do we go from here?” Are we entering a more stable period in the economy and the market, similar to the periods of relative stasis in the geological record? We are optimistic that this may in fact be the case and that the markets will return to a less volatile part of the cycle. But, with history as our guide, we know that even the greatest bull markets have experienced corrections along the way. While certain individual stock or sector valuations might look stretched, we believe the market as a whole has more room to run. Strong GDP growth and increasing earnings expectations for this year, a potentially lower-for-longer interest rate environment, accommodative fiscal and monetary policies, a healthy and robust financial system, low unemployment and solid wage growth, and a measured reopening of certain parts of the economy all support the market moving higher from here.

We remain committed to our shareholders as we thoughtfully navigate these unprecedented times. We know that you have a multitude of investment options to choose from, and we are grateful for the trust you put in us and your continued interest and investment in our family of Funds. Should you have any questions or would like to speak with us, please don’t hesitate to call us directly at (800) 966-4354.