It’s one of the most famous tales of baseball lore, involving perhaps the game’s most mythological character.
On October 1, 1932, at Wrigley Field in Chicago during the fifth inning of Game 3 of the World Series, Babe Ruth of the New York Yankees pointed to the center field bleachers during his at bat.
The Bambino sent the next pitch over the center field wall for a home run.
Film confirms the gesture, but the exact meaning of it has never been determined. Makes for a great story, though, and now baseball historians, fans, and even casual observers understand what we mean when we talk about “Babe Ruth’s Called Shot.”
But there’s is absolutely no ambiguity about what Chief Investment Strategist Louis Basenese said on February 27, 2016.
And the meaning of what he said on video is crystal clear.
It, too, is a story that bears repeating… particularly in light of the fact that the Russell 2000 index is all over headlines and newsfeeds for “breaking out” and “pushing toward a new all-time high” and “leading the rally.”
The Russell 2000 — the most widely cited benchmark for small-cap stocks — traded at a 52-week high earlier this week and is now up 7.8% on a year-to-date basis. The S&P 500 is up 6.7%.
The one-year picture looks a bit different: The small-cap index is up 1.1% versus the S&P’s 4.6%.
But the Russell 2000 lagged the late 2015 large-cap rally and fell harder during the early 2016 sell-off.
And by February, small caps were considered dead by many Wall Street types.
As I wrote on July 28, “The Wall Street group-thinkers — one from Société Générale, the other from Oppenheimer Funds — talked up the S&P 500 at a time when that index was outperforming the Russell 2000 by more than 80%.”
Those group-thinkers took to CNBC in mid-February to proclaim the “death of small caps.”
And sure, from January 1 through February 17, the S&P was down 6%, while the Russell 2000 was down 11%.
But from February 27 through July 28, when I first recounted the tale of Lou’s particular feat of derring-do, the Russell 2000 put up a gain of 18% versus 11.2% for the S&P 500.
Over the last couple trading weeks, though, as word of this small-cap outperformance has gone from the lips of experts like Lou to the mainstream financial media, the crowd is moving in.
As noted market philosopher and proprietor of The Reformed Broker blog Josh Brown recently wrote, “A simultaneous rip higher in cyclicals, high betas, small caps, and financials doesn’t suck.”
Still, it’s time for short-term caution on our favorite asset class.
But the long-term opportunity persists. That’s because Wall Street doesn’t devote the resources it once did to researching smaller companies. And that creates rampant inefficiency in pricing.
We, on the other hand, take time to do the primary due diligence necessary to create an information advantage. This information advantage translates into higher returns over the long term.
The approach we take is based on a set of principles that we think make for a good plan to build, preserve and grow wealth over the long term.
It starts with being numerate. Our research analysts are good with numbers. They understand how to read financial statements and balance sheets.
From there, we place a premium on understanding value, or the present value of free cash flow.
Another major element in our success is to understand the industries we follow and to know how a particular company fits into that industry’s cycle — including barriers to entry, the economics of the business, and management’s skill at allocating capital.
At the same time, valuation metrics have limitations. They provide a snapshot, but understanding value is a truly multi-faceted process.
A critical factor for evaluating small-cap stocks, particularly those that operate in high-tech businesses, is to properly assess management’s approach to making money. Strategy is key.
When it comes to taking apart quarterly and annual reports, it helps to be able to make effective comparisons between expectations and fundamentals.
Our mindset — based on the fact that there are few sure things in this game — is oriented around probabilities.
And when the facts change, we’re not afraid to change our minds. We think constant education is a good thing. We choose to update your views. Beliefs are hypotheses to be tested, not treasures to be protected.
That means being aware of our behavioral biases, such as the negativity bias we discussed in the August 11 Wall Street Daily. Being aware of our biases helps minimize constraints on clear thinking.
Finally, reading is a big part of what we do. Constantly refreshing the brain is the best way to keep an open mind. We’re also careful to avoid confirmation bias: We seek out viewpoints contrary to our own.
The goal for Wall Street Daily’s premiums services – including True Alpha and VentureCap Strategist – is to identify undervalued high-quality companies with proven revenue streams and proven products that are demonstrating rapid growth.
I’ve said it before and I’ll say it again: It’s generally a great idea to ignore big, bold pronouncements made on CNBC.
Like a proliferation of mainstream headlines touting a particular market theme, it’s a classic contrarian indicator.
If we stick to our principles, we’ll be able to avoid group-think.
And we’ll build real wealth over the long term.
Old Things New
One of the best cinematic interpretations of group-think gone horribly wrong is the 1943 American Western film noir The Ox-Bow Incident, based on the 1940 novel of the same name by Walter Van Tilburg Clark.
Directed by William Wellman, it stars Henry Fonda and Henry Morgan (Colonel Sherman T. Potter in the TV version of M*A*S*H) and features a young Anthony Quinn.
Gil Carter (Fonda) and Art Croft (Morgan) are passing through Bridger’s Wells, Nevada. They stop at Darby’s Saloon, where Gil soon gets into a brawl due to his drunken, depressed condition. (He’s back in town seeking a lost love.)
Soon, word comes to the saloon that a local farmer has been murdered and his cattle stolen. Suspicious minds turn to Gil and Art.
The townspeople form a posse to seek immediate justice. Gil and Art join the mob to avoid its wrath.
The posse rides out and eventually finds three men outside town in possession of the cattle in question. They’re determined to execute justice on the spot.
The posse votes on whether the men should be hanged or taken back to face trial. Only a handful, including Gil and Art, favors removing them to town for trial. The rest support immediate hanging. Gil tries to stop it, but is overpowered.
The suspected rustlers are hanged. After the lynching, the posse heads back toward Bridger’s Wells. They meet the sheriff, who tells them that the local farmer is not dead and that the men who shot him have been arrested.
The men of the posse gather in Darby’s Saloon and drink in silence.
Turner Classic Movies ran it on July 26, and I had the good sense to record it.
The bottom line for Wall Street Daily is that we don’t go with the crowd. Be your own investor.
Editorial Director, Wall Street Daily