A guest talking-head on CNBC recently declared that we’re witnessing “the death of small caps.”
The thing is, I know a guy who knows a thing or two about small-capitalization stocks… and a lot more than that about small-cap technology stocks.
That would be Wall Street Daily Chief Technology Analyst Lou Basenese.
Lou focuses very intently on small-cap stocks in VentureCap Strategist.
And in Digital Fortunes he provides insights, investment analysis, and money-making recommendations based on the world’s most transformational technology trends.
Lou doesn’t take proclamations like the one from this CNBC guy lightly.
The Information Advantage
Lou identifies a number of reasons why we’re not witnessing the death of small caps.
Indeed, he makes a compelling argument that we’re about to see a resurgence for the group – particularly small-cap tech stocks.
The No. 1 reason is about “opportunity.”
Wall Street simply doesn’t do the work it once did researching small-cap companies.
So the small-cap space is one area of the market that’s defined by “rampant inefficiency.”
There’s a lot of room for us – if we’re willing to do the extra due diligence – to gain an information advantage.
This information advantage translates into higher returns.
We can fill this research void and create for ourselves outstanding profit opportunities. In fact that’s what Lou does in VentureCap Strategist.
This is the fundamental rebuttal to the CNBC guy’s proclamation.
Where Capital Flows
Two more separate forces point to a small-cap resurgence.
First, we’re seeing lackluster and still-waning performance in private markets.
The venture capital market exploded in recent years, topping $38 billion of new investment during the third quarter of 2015. These are levels not seen since the Dot-Com Bubble.
At the same time, the VC market, as has been widely reported, got a little frothy.
Lo and behold, during the fourth quarter of 2015 VC money flows ebbed, declining by 30% compared to the third quarter. And “mega-financing” rounds ($100 million or more) were down by about 50%.
Second – and the key to Lou’s presentation today – is this: “Capital flows to where it’s treated best.”
Fixed income provides a good illustration. Capital flows into bonds denominated in currencies that pay the highest interest rates relative to risk.
The folks who run growth-oriented funds are no different than those who manage fixed-income portfolios: They follow performance.
And right now these folks aren’t getting the performance they expected from their VC investments.
Lou makes the important point that the field of VC investors has greatly expanded in recent years, with traditional “mega” mutual fund companies such as Fidelity Investments stepping into the game.
Sure enough, Fidelity recently wrote down the value of its venture portfolio.
Because they’re not being treated well in the private market, big money managers aren’t going to be deploying more capital there.
But money that’s flowed from the private market into the public market “has performed terribly too.”
The top initial public offerings (IPO) since 2012 have underperformed dramatically – see FitBit Inc. (FIT), Twitter Inc. (TWTR), Box Inc. (BOX), and Square Inc. (SQ) – based on their respective offer prices and performance since their public listings.
If you look at peak prices days after IPOs, the results “would be even more horrific.”
(Lou has warned against investing in these IPOs in Digital Fortunes.)
The bottom line is that “capital is not being treated well in these traditional areas of outperformance for growth capital managers.”
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Here’s the multi-million-dollar question: Where will these managers look next?
They’re going to look for opportunities to generate excess returns. And they’re going to want something else they’ve been missing: liquidity.
As Lou notes, “All roads point to small-cap technology names.”
Money will flow into particular small-cap companies (defined by market capitalization of $2 billion and below), not the whole sector. We’re not talking “development-stage” companies.
We’re talking about “undervalued high-quality companies with proven revenue streams and proven products that are demonstrating rapid growth.”
It’s generally a great idea to ignore big, bold pronouncements made on CNBC.
This one about the death of small caps could be particularly destructive if you think about it in “opportunity cost” terms. It’s a classic contrarian indicator.
Follow it… in the opposite direction.
This is a classic Graham/Buffett opportunity: high-quality growth at a low price.
Lou and his research team are focusing efforts on these opportunities.
Chief Income Analyst Alan Gula highlights another beaten-down group of stocks, financials.
Indeed, since mid-July 2015, when the S&P 500 Index was last near its all-time high, financials have underperformed even the beleaguered energy sector.
As Alan notes, U.S. banks are better capitalized than their global peers. That doesn’t necessarily translate to better stock-market performance.
There are two major factors at play here: an unfavorable yield curve and fear of European contagion.
The question is whether it’s a good time to buy the U.S. banks.
Alan has your answer.
Global Markets Analyst Martin Hutchinson chimes in with a survey of global central banks and their most recent attempts to combat slowing growth.
We’re talking negative interest rate policy, or NIRP. U.S. Federal Reserve Chair Janet Yellen said during recent testimony before the House Financial Services Committee that NIRP is not “off the table.”
NIRP would be bad for banks.
Indeed, as Martin notes, “By pushing interest rates negative, central banks will achieve the precise opposite of their stated goals.”
Senior Analyst Jonathan Rodriguez has his eyes squarely on the most important market season that doesn’t involve earnings: hedge fund reporting.
These “secretive institutions” are required by the Securities and Exchange Commission to disclose their long portfolios to the public via the quarterly filing of a Form 13F.
According to Jonathan, “The average investor has the invaluable opportunity to see where the ‘smart money’ is deploying their capital.”
And Jonathan identifies a favorite stock among hedge fund managers.
Senior Correspondent Shelley Goldberg has good news for us regular folk.
The U.S. House of Representatives passed H.R. 2187, known as the Fair Investment Opportunities for Professional Experts Act.
Part of the measure includes an expanded definition of “accredited investor.”
Those who meet the definition are able to invest in many opportunities that aren’t registered with the SEC and aren’t open to non-accredited investors, including private companies, hedge-fund offerings, private equity funds, and venture capital funds.
Finally, “You don’t need a weatherman to know which way the wind blows” is a line from the great Bob Dylan’s “Subterranean Homesick Blues.”
The lyric provided the name of a notorious radical left-wing organization of the 1960s and 1970s.
This is a little more mundane, but you may no longer need a weatherman if, as Senior Analyst Greg Miller reports, IBM Corp. (IBM) is able to successfully combine assets recently acquired from The Weather Channel with its Watson computer to produce the ultimate weather forecasts.
You say you want a revolution? How about reliable meteorology?