Amid the Noise: Four U.S. Value Equity Themes to Monitor

The tremendous uncertainty we are now seeing in politics, inflation, and interest-rate policy has slowed customer demand and led many companies to delay capital spending in several pockets of the small- and mid-cap equity sector. While some may see this as a reason to take cover, as long-term value investors focused on fundamentals, we know that uncertainty can often create meaningful opportunities. Here are four themes we see evolving in the coming months.

1. Holding Pattern: A Wait-and-See Industrial Economy

Short-cycle industrials, such as machinery and distributors, have seen a slowdown in activity. In these sectors, shorter business cycles cause demand and production to fluctuate more rapidly in response to changes in the economic environment. For now, demand has wavered (reflecting customer de-stocking), capital spending has been delayed, and production outlooks have weakened.

In the near term, we are closely monitoring several industrial demand factors. First, management teams have reported softer domestic demand, with inflation, high interest rates, and the upcoming U.S. election dampening customer sentiment. Second, U.S. purchasing managers’ indices (PMIs) below 50 indicate slightly lower demand, which is consistent with company commentary on choppy order trends. Third, the U.S. Institute for Supply Management (ISM) manufacturing PMI was worse than expected in October, dropping to 46.5 (the lowest since June 2023).

While some industrial sectors have slowed, we believe others show meaningful potential.

We expect these choppy demand trends to persist through 2024, especially as companies report longer quote-to-order times—a historical early warning for slowing capital investments. Delays in capital spending could also be extended if customers lose confidence. That said, we believe clarity from the U.S. election may improve spending as businesses gain visibility on the regulatory direction for the next four years.

While some industrial sectors (such as nonresidential construction) have slowed, we believe others (including data center construction and infrastructure) show meaningful potential. Longer-cycle industrials, closely tied to customer capital expenditures, are also in a holding pattern, with customers waiting on three fronts: lower borrowing costs following U.S. Federal Reserve (Fed) rate cuts, the upcoming election results, and the continued release of infrastructure stimulus (such as the Chips Act, Infrastructure Investment and Jobs Act, and Inflation Reduction Act). Much of this demand cannot be delayed indefinitely.

Longer term, we believe several secular trends should support industrial growth over the next decade: infrastructure, electrification, reshoring and supply chain diversification, sustainability, automation, and productivity gains from artificial intelligence (AI) adoption.

2. Prolonged Downturn: Trucking in Particular

While much of the market, particularly larger growth-oriented U.S. equities, has priced in a “soft landing” narrative, several industries have slipped into a prolonged recession. The transportation sector, especially trucking, is one such group.

During the COVID-19 pandemic, impressive margin expansion, aided by government stimulus, drove trucking costs per mile to record highs and allowed smaller carriers to strengthen their balance sheets. For context, ground transportation costs peaked at $2.50 per mile in November 2021, significantly above previous highs of $2.00 and $1.75 in 2018 and 2014, respectively.

However, the factors that propelled the trucking industry’s post-pandemic success are now complicating investors’ efforts to determine the bottom of the cycle.

We are optimistic that a recovery in trucking margins may be near.

With abnormally high inflation and a weakened trucking environment—due in part to the post-pandemic supply chain constraints—smaller carriers have been able to use their stronger balance sheets to pay down equipment costs. In past cycles, many of these “mom and pop” carriers would have exited, reducing overall capacity, but this hasn’t occurred to the same extent this time around.

These distortions have suppressed the trucking sector’s true cost per mile, making accurate modeling difficult for the market. In previous trucking cycles, the period from peak to trough has typically lasted about 24 to 30 months. Now, nearly three years since the last peak, we are optimistic that a recovery in trucking margins may be near.

With many smaller carriers having exhausted their cash reserves and the spread between contract rates and cost per mile narrowing to record lows, many trucking companies are signaling expectations for sharp margin increases. Even if margin forecasts are slightly off, we believe the tight spread between contract rates and cost per mile suggests a floor for trucking margins, as carriers rarely offer rates below their own costs per mile.

3. The Trade Down: Consumer Sectors Suffer

Although the U.S. economy has continued to grow despite rapidly rising interest rates, thanks to a resilient consumer, there are signs of cracks in consumer spending.

Automobile component retailers, which supply and distribute aftermarket automotive products (such as tires or filters) exemplify this strain. Unlike some consumer sectors bolstered by high-end buyers, the auto component and supply industry has faced severe headwinds as consumers “trade down” to lower-cost options.

This trend has been amplified by a shift from consumers handling repairs themselves to relying on professional services. Elevated inflation has pressured automotive component retailers whose “do it yourself” (DIY) business traditionally served cost-conscious consumers. Now, with persistent price increases, DIY projects have lost appeal, leading many to pivot toward “do it for me” (DIFM) services. This has ultimately reduced year-over-year same-store sales growth, a prominent metric for these companies, which are focused on how much customers spend per visit rather than transaction growth.

The auto component and supply industry has faced severe headwinds as consumers “trade down” to lower-cost options.

In addition, many consumers have traded down in quality within DIFM to cut costs, offsetting some of the margin expansion DIFM providers typically enjoy. Lower-end consumers are also cutting back, opting out of discretionary vehicle accessories, and even deferring essential maintenance—further dampening sales growth across the industry.

While investor sentiment toward this market remains pessimistic, we are optimistic that consumers will not defer these costs indefinitely. Many of these companies currently trade at single-digit price-to-earnings (P/E) and enterprise value to earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) multiples, making them potentially attractive from a valuation perspective moving forward.

4. Banks Pause: Loan Growth Resumption Imminent?

Bank lending, which has historically been correlated with economic activity, appears to have paused—but given expectations of additional interest-rate cuts, we expect it to increase soon.  The market has taken notice to the potential rebound with shares of regional banks within the Russell 2000 Value Index surging over 15% in the third quarter on a rebounding growth outlook, improving credit quality, and a potential pickup in mergers and acquisitions (M&A).

In the most recent quarter, most banks beat earnings estimates, though loan growth had been modest, with generally flat to low-single-digit increases attributed to election uncertainty and elevated commercial loan payoffs after the Fed’s 50-basis-point cut.

Deposit growth was flat or in the low single digits as banks reduced the term lengths of CDs to less than six months, offering rates around 4.00% to 4.25%. This was a shift from a year ago, after the Silicon Valley Bank collapse, when banks were offering one-year CDs with rates over 5.00%.

Credit quality held strong in the third quarter, aside from minor charge-offs in office and commercial/industrial (C&I) loans. M&A consolidation talks also intensified, highlighted by the merger announcement between two notable small- to mid-cap regional banks. Finally, net interest margin (NIM) guidance was flat to slightly up, except for asset-sensitive banks.

Looking ahead, market sentiment remains optimistic that post-election clarity and additional rate cuts have the potential to boost loan growth and net interest income (NII) in 2025, with consensus expectations of a possible double-digit average earnings increase for small- to mid-cap banks next year.

With the prospect of additional rate cuts looming, we believe the industry should benefit from accelerating loan growth, a favorable NIM and earnings per share (EPS) outlook, and solid capital return potential. We believe this backdrop could set the stage for better-than-expected growth into 2026 and makes shares of regional banks, that are trading in line with or below peers, a compelling value opportunity.

Greg Czarnecki is a portfolio specialist and research coordinator on William Blair’s U.S. value equity team.