Market Commentary

With the coming change in the administration, there is a renewed focus on potential policy changes and the impacts they may have on both the economy and the financial markets. As with any presidency, policy is not just the product of the occupant of the White House, but also key Cabinet nominees and the size of the congressional majority. With this latest election, that majority (and hence control of each congressional body) is very narrow. In the Senate, a 50/50 split gives Democrats control only by virtue of Vice President-elect Harris casting the deciding vote. In the House, Democrats outnumber Republicans by a scant 222-213 majority. 

Though their advantage is slim, Democrats have secured control of Congress and the White House. However, passing transformative legislation will prove difficult given the competing factions within the Democratic Party. More progressive members, particularly in the House, will push Congressional leadership to pass universal health care, the Green New Deal, reduced police funding and adding seats to the Supreme Court. Moderate Democrats will resist this progressive agenda and attempt to water down any legislation they view as too radical. Trying to arrive at a compromise within their own party that placates all sides may prove difficult, especially when House Democrats can only afford five defections if Republicans are united in opposition. 

Democrats in the Senate may have a similar issue. Moderate members like Senators Manchin, Tester, and Sinema may not support a strongly liberal agenda. In fact, Senator Manchin of West Virginia, whose term expires in two years, represents the second largest coal producing state. He may be the most resistant Democrat to overtly progressive legislation, especially on issues such as energy and the environment.  

We’re seeing early signs of this playing out in President-elect Biden’s Cabinet picks. He appears to be choosing moderate figures for key posts, particularly those that are relevant to the economy and capital markets. This has caused some unhappiness among a minority of progressive Democrats, who have been vocal in their displeasure. For the Treasury Department, he has selected Janet Yellen, the former Chair of the Federal Reserve. A committed Keynesian economist, she is hardly a radical and should easily be confirmed. While she may support sustained budget deficits and tolerate a moderate increase to inflation, it is unlikely that she would lobby for the more aggressive stimulus packages that have been proposed. Two additional key Cabinet posts that we have been watching closely are Labor and Commerce. Marty Walsh and Gina Raimondo, respectively, were nominated to head those departments. Walsh has long-standing ties with organized labor and Raimondo has experience in venture capital and the tech industry. Overall, these nominations suggest a business-friendly posture from the incoming administration. 

Due to the narrow divisions along party lines in the House and Senate, we should not expect any transformative legislation. In a Congress so evenly divided, significant bills can only be passed on a bipartisan basis, such as during President George W. Bush’s first term with Tax Reform (EGTRRA), USA PATRIOT Act, Medicare Prescription Drug Act, and No Child Left Behind. President Obama’s legislative accomplishments were limited to his first two years in office when his party controlled the House and had a super-majority in the Senate. 

Instead, we predict that policy impacts are more likely to arise via regulation from Cabinet departments. Looking at years 3-8 of the Obama administration, policy impacts were limited to Cabinet level regulation and executive actions. With the exception of potential stimulus measures that could move forward in the coming year, we expect policy in the Biden administration to play out similarly.

Strategy Review

The Pacific Ridge Capital Partners’ Small Cap Value strategy rose 34.7%* during the fourth quarter of 2020, outperforming the 33.4% return of the Russell 2000® Value Index (“Index”). Over the trailing one-, three- and five-year periods, the strategy returned -3.8%*, 0.1%* and 7.4%* (annualized), respectively, compared to the Index returns of 4.6%, 3.7% and 9.7%. Since inception on August 1, 2010, the strategy returned 10.0%* annually versus 10.0% for the Index.

*Preliminary results.  For additional performance information, see the related GIPS® Report on the last page

Top Contributors

COHU (“COHU”) is a manufacturer of semiconductor test and inspection handling equipment. The stock moved higher during the second half of the year on the heels of an improved outlook in the semiconductor space. The company is expecting a notable tailwind in the coming years, thanks to increased demand for radio frequency testers required by the ongoing expansion of 5G networks. We saw evidence of this with their most recently reported earnings, as the outlook for the fourth quarter greatly exceeded analyst expectations and the stock moved substantially higher. 

Meta Financial (“CASH”), a specialty finance lender, reported another solid quarter of earnings in November, with the stock rebounding from a sell-off earlier in the year. Over the years, the company evolved from a community bank to a specialty lender with a low-cost deposit base. Consensus estimates moved back near their prior levels as analysts again became comfortable with the company’s credit risk in light of recent economic tailwinds. 

Shyft Group (“SHYF”), a manufacturer of commercial vehicles, has seen its stock nearly triple from the lows earlier this year. With the shift to online shopping accelerating over the past year, demand for delivery vehicles has significantly increased. Estimates have steadily moved higher as analysts raise their expectations for both sales and EBITDA margins heading into 2021 and 2022. The company also reduced its debt following the sale of a non-core business, resulting in a very strong balance sheet with high levels of cash flow projected in the coming years.

Chef’s Warehouse (“CHEF”), a distributor of specialty food products, reported mixed earnings results during the quarter. There is still lingering concern that fourth quarter performance will be weak (increased COVID-19 case counts result in reduced restaurant traffic). However, the stock has rallied, thanks to the approval of COVID-19 vaccines that could lead to normalized traffic. 

Ultra Clean Holdings (“UCTT”) is a developer and manufacturer of critical subsystems in the semiconductor capital equipment industry. The stock was volatile through the year and rallied strongly during the fourth quarter following an earnings beat and an improved outlook heading into 2021. A recently announced acquisition is intended to drive top-line growth over the longer-term.

Top Detractors

Asure Software (“ASUR”), is a cloud-based human capital management and workplace management software provider. The company reported earnings during the quarter that were slightly short of expectations. The stock then came under additional pressure late in the quarter as the company raised more capital through a secondary offering that investors were not expecting. 

Standard Motor Products (“SMP”), a manufacturer and distributor of replacement parts for motor vehicles, sold off sharply in December following the loss of a key customer. The impact to earnings is expected to be 6-7% per year as the company looks to reduce expenses to offset the lost revenue. Also, business is expected to be slower through at least 2022 as fewer miles are being driven. Management has worked over the last four years to better weather a down draft in business. These developments will test those efforts. 

PRA Group (“PRAA”), a debt collection firm, traded down slightly after a strong move higher during the third quarter. The company stands to benefit in the coming years from an increased supply of delinquent borrowers and charged off receivables from lenders. Accordingly, the stock rallied sharply in the early days of the pandemic but has since moderated following a substantial stimulus package that buoyed consumers. The degree to which PRAA will benefit from the economic fallout of the coronavirus remains to be seen.

Heritage Insurance (“HRTG”), a property and casualty insurer, traded down over the second half of the year as the 2020 Atlantic hurricane season was one of the most active ever. This led to higher claims costs that negatively impacted earnings and book value. While this could provide a tailwind to rates and earnings going forward, investors remain in “wait and see” mode. Management has done a good job of diversifying their book of business away from the deteriorating Florida market, and they should experience more predictable earnings going forward.

Global Medical REIT (“GMRE”) is a real estate investment trust specializing in health care properties. After strong performance during the second and third quarters, the stock pulled back slightly in December. The company is performing well during the pandemic. Most of their tenants have not experienced material impacts to their operations or had difficulty meeting their lease payments. Management continues to pursue additional acquisitions to further expand their portfolio.

**Past performance does not guarantee future results. The holdings identified do not represent all the securities purchased, sold or recommended to clients. Top contributors and detractors to return represent those securities that had the largest positive and negative total contribution to the overall portfolio return for the quarter.  A complete list of contributors to portfolio return can be obtained by contacting Peter Trumbo, Chief Compliance Officer, at 503-886-8972 or by email at Peter.Trumbo@PacificRidgeCapital.com. For additional information, see the related GIPS® Report on the last page.

Market Capitalization Analysis

There was a significant size bias tailwind during the quarter as smaller companies in the Index outperformed larger companies. Those with a market cap under $1 billion in the Index gained 38.0%, versus a return of 31.4% for companies with a market cap above $1 billion. The strategy had 81.5% of its holdings in companies with a market cap below $1 billion, compared to 30.1% for the Index.

Style Analysis

There was a minimal value-bias during the quarter. However, strong performance of unprofitable companies in the Index was a modest headwind, as those stocks returned 46.5%, versus a gain of 30.4% for firms that were profitable. The strategy had 14.4% of its holdings in unprofitable companies, compared to 20.3% for the Index.

Economic Sector Analysis

The strategy’s performance in Consumer Discretionary and Information Technology contributed approximately 240 basis points of excess return relative to the Index. However, performance in Industrials and Materials detracted approximately 290 basis points versus the Index. The strategy’s lack of exposure to the Communication Services and Utilities contributed approximately 50 basis points of excess returns during the quarter. 

Market Outlook

Equities continued to rally in the fourth quarter of 2020 aided by the vaccine rollout and removal of election uncertainty. Despite COVID outbreaks around the holidays, the US economy edged higher with expectations of mid to high single digit GDP growth for 4Q20. The outlook for 2021 is for more normalized growth of 3-4% but could be more heavily weighted to the back half of the year. This outlook is dependent on the scale of ongoing COVID resurgence and rate of inoculation as the nation gradually returns to normal. We remain cautious in the near-term, given continued uncertainties related to the pandemic.

As always, we continue to search for companies that demonstrate an ability to earn a fair return on capital. We welcome any questions or comments you may have and thank you for your continued support.

Sincerely,

Pacific Ridge Capital Partners

Investment Team Additional Professionals
Mark Cooper, CFA® Co-Senior Portfolio Manager Peter Trumbo Chief Operating/Compliance Officer
Dominic Marshall, CFA® Co-Senior Portfolio Manager Mike McDougall Senior Trader
Ryan Curdy, CFA® Portfolio Manager Veronica Orazio Operations Assistant
Justin McKillip, CFA® Senior Analyst
Adam Boyce, CFA® Senior Analyst

Regulatory Disclosures

The contributors and detractors to return, market capitalization weightings and total effect, economic sector weightings and total effect, portfolio characteristics, and top ten holdings for the Small Cap Value Composite are based on a representative account within the strategy. The representative account statistics are shown as supplemental information and complement the composite's GIPS® Report as provided on the last page. 

The Russell 2000® Value Index measures the performance of the Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. For comparison purposes, the Index is fully invested, which includes the reinvestment of income. The return for the Index does not include any transaction costs, management fees or other costs. 

In order to maintain consistency when comparing the Small Cap Value strategy to the Russell benchmark, the Firm utilizes FactSet’s outlier methodology calculations which provide a comparable portfolio characteristic calculation methodology as Russell applies to its indices.

The information provided should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in our strategy at the time you receive this report or that securities sold have not been repurchased. It should not be assumed that any of the holdings discussed herein were or will be profitable or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. Past performance is no guarantee of future results.

Although the statements of fact and data in this report have been obtained from, and are based upon, sources that the Firm believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitute the Firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.

Disclosures                                                                                            

Pacific Ridge Capital Partners, LLC (“Pacific Ridge”, “PRCP”, or “the Firm”) is a 100% employee owned investment advisor registered with the Securities and Exchange Commission under the Investment Advisors Act of 1940. The Firm was established in June 2010, and has one office located in Lake Oswego, Oregon. Pacific Ridge claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Pacific Ridge has been independently verified for the periods June 10, 2010 through September 30, 2020. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. The Small Cap Value Composite has had a performance examination for the periods June 10, 2010 through September 30, 2020. The verification and performance examination reports are available upon request.

The Small Cap Value composite was created and incepted on August 1, 2010. The Small Cap Value composite comprises fully discretionary portfolios managed by the Firm invested primarily in an equity portfolio of small companies with market capitalizations similar to those found in the bottom three-quarters of the Russell 2000® Index. The strategy ascribes to a disciplined bottom-up fundamental  selection process with an emphasis given to the cash flow generating capabilities of a company. The strategy’s objective is to outperform the Russell 2000® Value Index which is used as our benchmark. Eligible portfolios must be managed for a full calendar month prior to inclusion in the Small Cap Value composite. Composite dispersion is measured using an asset weighted standard deviation of gross returns of the portfolios included for the entire year. Returns and asset values are stated in US dollars.

The Russell 2000® Value Index measures the performance of the Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. For comparison purposes, the index is fully invested, which includes the reinvestment of income. The return for the index does not include any transaction costs, management fees or other costs.

Sources: Pacific Ridge; FactSet Research Systems (“FactSet”); and Russell Investment Group (“Russell”) who is the source and owner of the Russell Index data.

Returns for the Small Cap Value composite are presented gross and net of management fees and other expenses and includes realized and unrealized gains and losses, cash and cash equivalents and related interest income, and accrued based dividends. Net returns are calculated by deducting the highest annual management fee of 1.00% from the quarterly gross composite return. Performance-based fees are available upon request. All returns are calculated after the deduction of the actual trading expenses incurred during the period. The management fee schedule and total expense ratio for the Small Cap Value Fund, which is included in the composite, are 1.00% on all assets and 1.08%, respectively, as of the most recent audit. Total fees for the fund may not exceed 1.25% annually.

The fee schedule for separately managed accounts is a flat rate of 1.00%.

The portfolio characteristics, sector weightings and attribution analysis for the Small Cap Value composite are based on a representative account within the strategy. The representative account statistics are shown as supplemen­tal information. The Firm maintains a complete list and description of composites and pooled funds, policies for valuing portfolios, calculating performance, and preparing GIPS Reports which are available upon request by contacting Peter Trumbo, Chief Compliance Officer at (503) 886-8972 or Peter.Trumbo@PacificRidgeCapital.com.

GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

Top 5 and Bottom 5 Performing Securities represent those security holdings that had the largest positive and negative total contribution to the portfolio return. Top 3 and Bottom 3 Economic Sectors represent those sectors that had the largest positive and negative total contribution to the portfolio return.

In order to maintain consistency when comparing the Small Cap Value strategy to the Russell benchmark, the Firm utilizes FactSet’s outlier methodology calculations which provide a comparable portfolio characteristic calcula­tion methodology as Russell applies to its indices.

The information provided should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in our strategy at the time you receive this report or that securities sold have not been repurchased. It should not be assumed that any of the holdings discussed herein were or will be profitable or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. Past performance is no guarantee of future results.

Although the statements of fact and data in this report have been obtained from, and are based upon, sources that the Firm believes to be reliable, we do not guarantee their accuracy, and any such information may be incom­plete or condensed. All opinions included in this report constitute the Firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.