Core Insights - The investment landscape in 2025 has been heavily influenced by the rise of Artificial Intelligence (AI) companies, leading to significant market gains across major indices, with the S&P 500 up 17.88% and the Russell 2000 up 12.81% [4] - There is a growing concern about a potential market bubble, as high-quality businesses have underperformed low-quality ones, particularly in the small-cap sector [6][7] - AI-related stocks have dramatically impacted the S&P 500, accounting for 45% of its market cap and 78% of its returns since the launch of ChatGPT in November 2022 [12][15] Investment Performance - FMI's portfolios have generated solid double-digit annual returns over the past three years but have lagged behind broader indices due to a focus on business quality and valuation [5] - The disparity in performance between high-quality and low-quality stocks has been stark, with low-quality stocks outperforming significantly in 2025 [6][7] Market Dynamics - The MSCI EAFE Quality Index has underperformed the MSCI EAFE by approximately 10% in both local and USD terms, indicating a broader trend of low-quality stocks outperforming in international markets as well [8] - The capital spending in the tech sector, particularly related to AI, has contributed significantly to U.S. GDP growth, accounting for 40%-45% through the first nine months of 2025, a stark increase from less than 5% in the same period of 2023 [18] Company Insights - Hayward Holdings Inc. is highlighted as a resilient small-cap company in the pool equipment market, with strong pricing power and a solid balance sheet, despite facing weak demand in the newly built and remodeled pool segments [26] - Accenture PLC is positioned to benefit from the AI boom, as its consulting services are increasingly in demand for enterprises adopting AI technologies, despite facing cyclical pressures [30] - Smiths Group PLC is transitioning to a more focused portfolio, improving its growth and profitability profile while maintaining a strong balance sheet [31] AI Impact - The concentration of AI-related stocks in the S&P 500 raises concerns about market sustainability, as these stocks have driven a significant portion of market returns and earnings growth [12][15] - The capital intensity of AI companies is increasing, with expectations that they will need to generate $2 trillion in revenue by 2030 to meet demand, which may not be achievable [21]

Core Viewpoint - The investment strategy is shifting towards quality value stocks, particularly in the industrial sector, as earnings growth expectations remain strong for 2026 [1]. Industrial Sector - The industrial sector is favored due to higher return on equity and solid demand, with earnings growth projected at 16% [2]. - Industrial companies are expected to benefit significantly from accelerated depreciation policies, which will stimulate tech capital expenditures [3]. - The aerospace and defense industries are experiencing robust demand, indicating a positive outlook for these sectors [6]. Defense Stocks - Defense stocks have outperformed most sectors, with Boeing's stock rising 40% since November [4]. - Investors are advised to embrace geopolitical risks through investments in defense stocks and metals, rather than attempting to trade on geopolitical headlines [5]. Mid and Small Caps - Mid-cap stocks are gaining attention, with a notable participation in the market, contrasting with the focus on mega-cap tech stocks [7]. - Small and mid-cap stocks are showing strong earnings momentum, particularly in the industrials and regional banks [9]. Regional Banks - Regional banks are experiencing double-digit earnings growth and active M&A activity, although they face potential headline risks and regulatory challenges [10]. Economic Outlook - The economy is showing signs of good growth with controlled inflation, countering fears of stagflation [12]. - Economic indicators such as PMI and ISM are expected to remain above 50, signaling positive growth [13]. - Inflation is projected to moderate into 2026, with housing prices stabilizing and energy prices remaining manageable [14].

Market Overview - The equity market experienced significant gains in 2025, with the Russell 2000, S&P 500, MSCI EAFE, and MSCI World increasing by 12.81%, 17.88%, 20.60%/31.22%, and 21.09% respectively, driven by a speculative "junk" rally and enthusiasm for AI-related companies [2] - Wall Street strategists are forecasting over 10% returns for the S&P 500 in 2026, which would mark four consecutive years of double-digit returns, a rare occurrence in market history [2] Investment Trends - FMI's portfolios have generated solid double-digit annual returns over the past three years but have not kept pace with broader indices due to a current market preference for low-quality investments [3] - High-quality businesses have underperformed low-quality ones sharply in the U.S. in 2025, despite long-term outperformance trends [4] - The small-cap sector has seen a significant outperformance of low-quality companies, with active managers struggling to keep pace during this "junk" rally [5] International Market Insights - The MSCI EAFE Quality Index has underperformed the MSCI EAFE by approximately 10% in both local and USD terms, indicating a global trend of low-quality stocks outperforming [6] - In Europe, the top-performing sectors in 2025 included Defense (+89.9%), Rate Sensitive Financials (+72.1%), and EU Miners (+55.5%), which are generally considered low-quality investments [6] AI Impact on Markets - AI-related stocks in the S&P 500 represent 45% of the index's market cap and have accounted for 78% of S&P 500 returns since the launch of ChatGPT in November 2022 [12] - The tech sector's capital spending has contributed 40%-45% of U.S. GDP growth in 2025, a significant increase from less than 5% in the same period of 2023 [15] - Major tech companies are expected to spend over $500 billion on capital expenditures in 2025, with a projected capex-to-revenue ratio of 29% in 2026 [21] Company-Specific Insights - Hayward Holdings Inc. is positioned well in the pool equipment market, with strong pricing power and a resilient business model, despite current weak demand [27] - Accenture Plc is adapting to the AI landscape, with expectations that AI adoption will drive demand for its consulting services, despite facing headwinds in IT spending [28] - Smiths Group PLC is transitioning to a more focused portfolio, with improvements in growth and profitability, supported by a strong balance sheet [29]

Core Viewpoint - Heartland Mid Cap Value Fund's fourth-quarter 2025 performance was negatively impacted by the underperformance of high-quality value stocks, while speculative and low-quality stocks gained attention, leading to widening valuation gaps [1]. Group 1: Fund Performance - The Fund's portfolio experienced a loss of 1.92% in the fourth quarter, compared to a 1.42% return from the Russell Midcap® Value Index [1]. - The underperformance of Quality Value holdings significantly affected the overall strategy performance during the quarter [1]. Group 2: MarketAxess Holdings Inc. - Heartland Mid Cap Value Fund initiated a new position in MarketAxess Holdings Inc. (NASDAQ:MKTX), which operates the largest electronic trading platform for corporate bonds in the U.S. [3]. - As of January 12, 2026, MarketAxess Holdings Inc. stock closed at $170.10 per share, with a one-month return of -5.22% and a 52-week loss of 21.48% [2]. - MarketAxess Holdings Inc. has a market capitalization of $6.356 billion [2].