Over the past 20 years, the S&P Small Cap Index (SML) has grown earnings 57% faster than the S&P 100 Index (OEX) (11% vs 7%)
That makes sense – small caps grow earnings off a lower base and so don’t suffer from the law of large numbers
And because earnings drive share prices
it should be no surprise to learn that the SML has beaten OEX by 36% over the last 20 years
And because they out-perform and grow earnings faster, they typically trade at a valuation premium
SML’s average PE has been 19.5
OEX’s average PE has been 16.8
for a PE relative of 1.2
Until now
OEX’s PE is 16.3
SML’s PE is 11.8
For a PE relative of 0.7 (more than two std deviations below the mean)
But won’t small caps get hurt in a recession?
Ah – well it varies from small cap to small cap
and why I think (unsurprisingly) you need Active managers to find the ones that will grow DESPITE a recession
because some companies will get crushed, especially those with lots of variable debt in a rising interest-rate environment
spoiler alert – I don’t think Index funds look at the type of debt a company owes …
Every week since 1987, the American Association of Individual Investors poll members for their views on the direction of the stock market over the next six months.
An average week has seen 31% of members thinking the direction is down (bearish) over the following six months.
But this week, 56% of people were bearish, and since 1995 there have only been 17 weeks with reading this negative or worse.
The four-week average of 58% is the most bearish 4 rolling weeks EVER
Remember, “Be greedy when others are fearful…”?
Well, investors aren’t just fearful, they’re absolutely terrified!
And if people are absolutely terrified, do you think you get good prices or bad prices?
You get great prices.
Now, I overlayed the price relative of the MSCI Small Cap Index / MSCI Large Cap index (blue line) with high levels of bearishness (red lines)
And do you know what I found?
Small caps typically out-perform AFTER periods of high bearishness – see the green arrows on the chart after red bars
But why?
I think once the fearful weak hands have sold, the “supply” of stock dries up so they move sharply to the upside
What’s the problem?
Most large Global Equity Fund managers CAN’T look at small caps – any position is far too small to matter to them
BUT small Global Equity fund managers like Ranmore can, #like and do
In fact, we’re absolutely full of them – that’s where the value is
And so now we sit and be patient
waiting for the storm to pass (as they always do)
for the selling to dry up
and for our holdings to move sharply to the upside
So if you also think small is beautiful, get in touch
Source: Bloomberg, AAII, MSCI, Ranmore
