Gabelli Funds, LLC

Gabelli's September 2023 update on the US market

U.S. equities dipped lower in September, as the S&P 500 suffered its biggest monthly decline since last December and its first back-to-back monthly decline in 2023. Historically, September has proven to be a challenging month for equities, with the S&P 500 averaging a 0.7% decline in September since 1945, the worst of any month. In addition, performance has declined in September in each of the last four years. During the month, treasury yields rose as investors are expecting that the Federal Reserve’s high-altitude interest rates may last longer than originally anticipated. The recent move in rates was driven by resilient macro data, rising energy prices and underwhelming disinflation momentum. Investors find themselves in an unusual situation where they can secure higher yields on short-term debt without the need to commit their funds to longer-term investments to achieve higher interest income. This is known as an “inverted yield curve”.
Small-cap stocks remained under pressure throughout the month, continuing their trend of underperformance relative to the broader equity market in the year 2023. We continue to see abundant opportunities in small to mid-cap stocks, given the compelling valuation of the Russell 2000 Value, which currently trades at only 10-12x earnings.
Market weakness continued in September for the convertibles market although convertibles continue to outperform underlying equities in weak markets. However, with over 40% of the market now fixed income alternatives, the moves in interest rates have weighed on valuations. We believe this environment presents an opportunity, and over the coming two years, we anticipate that many fixed income equivalents will accrete towards par, while new issuance will offer a more traditional asymmetrical return profile for convertible investors.
New convertible issuance has picked up over the past two months, and we saw a mix of issuance that included companies that are new to convertibles, along with some that are returning to refinance existing debt. This mix of issuance is good for the convertibles market, and it has generally been at attractive terms with higher coupons and lower premiums than many existing issues.  We have continued to see companies buying back convertibles in a transaction that is accretive to earnings and positive for the credit and we expect this bid to continue.
M&A results were mixed in September, as deals like Activision and Horizon Therapeutics progressed towards closing in October, while interest rate and market volatility in the market weighed on other deals. In September, the U.K. CMA said that Microsoft’s revised deal structure for its $70 billion acquisition of Activision (ATVI-$93.63-NASDAQ), that includes selling cloud gaming rights to Ubisoft, likely addresses its concerns and could clear the way for the deal’s final remaining regulatory approval. M&A activity in the third quarter increased 16% from second quarter levels, reaching $2 billion for the year, a decrease of 27% compared to 2022 levels but it is positive to see activity trending higher in recent quarters. New deal activity in September included Hostess Brands being acquired by J.M. Smucker for $5 billion, Splunk being acquired by Cisco for $26 billion, WestRock being acquired by Smurfit Kappa for $21 billion and NextGen Healthcare being acquired by Thoma Bravo for $2 billion. These deals are providing new opportunities for arbitrageurs to deploy capital that has been harvested in recently closed deals.