The fund blamed 90% of its underperformance on an IT underweight and said the focus on AI-winners is dangerous. It sees a 'perpetual motion machine' in hyperscaler spending.
Longleaf Partners Fund warned in its second-quarter letter that the stock market has entered a phase of speculative excess not seen before. The fund, run by Southeastern Asset Management, pointed to the Cyclically Adjusted Price/Earnings multiple at its highest level ever. Both earnings and the multiple on them are disconnected from long-run averages for the first time in history, the managers wrote.
The fund attributed nearly 90% of its relative underperformance in the quarter to an underweight position in Information Technology. Even the value index has become increasingly driven by AI-winner stocks, the letter said. “Hyperscaler (also known as the Mag7+Oracle without the semiconductor companies) FCF is below 2019 levels on a next twelve months’ basis.”
The managers described a “perpetual motion machine” in which hyperscaler, venture capital, and equity- and debt-raised money circulates, growing revenue and highly adjusted EBITDA. They said they feel the same way about potential SpaceX, Anthropic, and OpenAI IPOs as they did about the Fermi IPO last year. “The focus will eventually shift back to actual FCF per share, as it always does over the long-term,” the letter said.
The fund addressed the question of mean reversion directly. Brief shocks in 2020 (COVID), 2022 (interest rates), and 2025/26 (Liberation Day and Iran War) have been overcome by free money, the AI boom, and Trump-era changes. The managers said they have noticed signs that recent market winners are looking for ways to get off the “runaway train” while acknowledging they are running low on places to conquer. Microsoft’s outreach to the Wall Street Journal, showing regret for legitimizing OpenAI, is one example. Other mega caps are choosing the Citigroup-in-2007 route of blasting money into AI, which the fund said is only delaying the rush to a more crowded exit. Quant firm Jane Street also proactively reached out to the WSJ, suggesting it is running out of places to keep growing profits. “These factors and others combine for dangerous market structure dynamics,” the managers wrote. “We and others have been early pointing out the bubbling instability that is lurking, which likely means that the pressure is building up further before something dramatic happens.”
The fund’s portfolio is concentrated in 15 to 25 companies. Stocks at the lowest multiples of real free cash flow, such as Albertsons and Exor, were punished the most in the toughest parts of the quarter. The fund said it can win from FCF per share growth even if the broader economy turns down, from multiples that have room to increase, or from strategic actions that realize values.
Among holdings, Fortune Brands (FBIN) contributed in the quarter. The company announced it was exploring strategic alternatives for its Fiberon business and recruited Jesse Singh, former AZEK CEO, to lead the company. The fund said it engaged behind the scenes in a way that was helpful. Fortune Brands carries an Alpha Score of 47/100, reflecting a Mixed label. Regeneron (REGN) was a detractor after disappointing trial results for one of its pipeline drugs. The fund trimmed some of its holding earlier when the market was running hotter on Regeneron’s pipeline prospects. It said it has been encouraged to see the company lean into share repurchases when it has been most undervalued. Regeneron’s Alpha Score is 60/100, or Moderate.
People Inc. bid for control of MGM, and the fund said this can be a good way to grow and realize value. Avantor showed stabilization with a new CEO guiding to revenue growth and strong FCF generation in the second half of 2026. FedEx completed the spin-off of FedEx Freight, and the fund sold its small holding after it traded above its appraisal. Albertsons was a detractor as the market focused on peer Kroger’s mildly disappointing results. CNX Resources detracted after contributing in the first quarter; the fund added back at better prices after trimming earlier.
The fund purchased one new position in the quarter, a healthcare company it knows well and has made money owning previously. It exited Bio-Rad after another disappointing operational quarter.
“We hope you can sense how our level of disappointment with our trailing 12-month relative performance is outweighed by our conviction in our portfolio going forward,” the letter said. “We remain consistent with our disciplined Business, People, Price approach rather than chasing overpriced speculation.”
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