Since January, world markets have been selling off. As a result, a number of quality small cap businesses are now trading at very attractive multiples. Is now a good time to invest in quality small caps?
Back in June, I asked the question in my whitepaper: are we there yet. At that stage, noting the selloff in the equity market was entirely composed of a contraction in price-to-earnings (P/E) multiples, we pointed to the fact earnings per share forecasts were still positive and required some downward revision, leaving the market vulnerable to further declines.
By June the S&P500 had contracted 23.6 per cent from its 3 January high, dragging the ASX200 down 15 per cent along with it.
Today, it’s reasonable to assume a substantial amount of time has been afforded to analysts to review their earnings forecasts such that they might now, more reasonably, reflect outlooks for the remainder of 2022 and 2023.
It is perhaps the conversations those analysts are having with professional investors that has informed the latest investors sentiments survey published by Bank of America Merrill Lynch. That survey of 212 managers with more than US$610 billion in assets confirmed professional equity investors are now meaningfully ‘underweight’. Indeed, a record 52 per cent of respondents are underweight stocks, while cash levels jumped amid bearish sentiment exceeding the levels witnessed during the 2008/09 Global Financial Crisis (GFC).
We can safely say sentiment among expert equity investors is at a bearish extreme. And their bearishness is supported by concerns in the bond market that rates will continue to rise. A survey published last week by Deutsche Bank revealed 73 per cent of investors believe the yield on 10-year Treasuries is more likely to hit five per cent than one per cent. Back in June, 60 per cent of investors believed rates were more likely to hit five per cent than one per cent. The 10-year yield is at around 3.49 per cent.
The extent of bearish sentiment can also be seen in P/E multiples for U.S. small caps. As Figure 1, reveals, S&P600 SmallCap P/E ratios are also level with those seen during the GFC.
Figure 1. Yardeni S&P600 SmallCap P/E ratio
According to the latest Ed Yardeni price-to-earnings chart pack published 16 September 2022, small cap P/E ratios have only been this low twice in the last 23 years. The first time was during the GFC, and more recently, during the outbreak of the COVID-19 pandemic.
According to the American Association of Individual Investors (AAII) latest survey, which notably was taken before the large drop in markets, bearish sentiment – expectations that stock prices will fall over the next six months – pulled back by 7.3 percentage points to 46.0 per cent (Table 1.). Bearish sentiment is above its historical average of 30.5 per cent for the 42nd time in the past 43 weeks and is at an unusually high level for the 27th time in the last 35 weeks. The breakpoint between typical and unusually high readings is currently 40.5 per cent.
Table 1. AAII Sentiment Survey
The AAII bull-bear spread (bullish minus bearish sentiment) is –19.9 per cent and is unusually low for the 28th time in 34 weeks. The breakpoint between typical and unusually low readings is currently –10.9 per cent.
Turning points, like all market moves, occur amid uncertainty, and with margin debt having reportedly declined precipitously, along with meme stocks and crypto currencies, an argument can be built that financial excesses have been unwound.
The combination of P/E deratings, downward EPS forecasts revisions, and the unwinding of financial excess suggests investors with a longer timeframe are in a better position to assume reasonable returns from owning higher quality small caps. I remain invested in both the Montgomery Small Companies, and the Polen Capital Global Small and Mid Cap Fund.
We can never be sure what markets will do next. V-shaped recoveries are a rare exception. Typically, bear markets bottom over an extended period of time amid a process involving retests of the lows and wild volatility. Nevertheless, what I can be sure about is my returns from investing in these small cap funds today will be better than the returns I will generate from investing at the market highs.
For more on how today’s low P/E ratios set investors up for attractive returns read this.stocks pandemic covid-19 crypto currencies crypto small caps
Playing the infinite game: patient investing
In his 2019 book The Infinite Game, author Simon Sinek describes how taking a long-term view — what he calls adopting an infinite mindset — is critical…
In his 2019 book The Infinite Game, author Simon Sinek describes how taking a long-term view — what he calls adopting an infinite mindset — is critical for success. Although discussed in the context of leadership, the same principle applies to investing, which has historically favored those who take a long-term view rather than react impulsively to the inevitable ups and downs that occur on the path to creating wealth. Of course, while countless investors have demonstrated that the market rewards those who stay the course, the reality is that doing so isn’t always easy. On the contrary, it takes discipline, self-restraint, and patience.
Investors can quickly lose sight of this reality, particularly in the current environment. Faced with record inflation, rising interest rates, and geopolitical unrest, it’s only natural for investors to want to take action. Shifting strategies or pulling out of the market are among the ways that some investors try to insulate themselves from volatility. Yet the reality is that taking these or other similar steps rarely yields the desired outcome over the long term. Patience isn’t just a virtue. We believe it’s an essential ingredient in any successful financial strategy.
Why we believe patience pays off
As a society, we’re constantly bombarded with information that can either scare us or make us feel like we’re missing out. As a result, it’s easy to feel compelled to take steps we believe will safeguard our assets or to try to time the market or cash in on the latest trend. That’s one reason so many investors have shifted from a buy-and-hold mentality in recent years to one that favors trading securities much more frequently. While the desire to buy low and sell high is understandable, it’s virtually impossible to do so regularly without a crystal ball.
In our view, making a conscious decision to be patient is critical, even though it’s challenging. People are often hardwired to seek instant gratification. We want results, and we want them now. As such, we have a strong bias toward taking action to reach a resolution sooner rather than later, even when waiting can be the more prudent thing to do.
Practically speaking, that means that many investors are willing to sell their assets in a down market in the hopes of avoiding deeper losses. Our experience suggests that, in many cases, had they just remained invested, their outcome could have been markedly different. On the opposite end of the spectrum, those same investors are also prone to selling assets that have increased in value far too soon. While there’s nothing wrong with locking in gains, doing so can come at a high cost if it means missing out on a substantial upside.
With investing, taking action for action’s sake can lead to poor outcomes. Exhibit 1 shows the impact of missing the one, five, and ten days in the market with the highest total return for the Russell 1000 Growth and the Russell 2000 Growth over the past 20 years.1 Notably, some of these “best days” can occur during highly uncertain times, such as the challenging market downdraft at the end of 2008, and the tumultuous early phase of the COVID-19 pandemic in 2020. To us, this underscores the difficulty of attempting to time the market and the wisdom of staying invested for the long term.
Exhibit 1: Impact of Missing the Best Days in the Stock Market, August 31, 2002 to August 31, 2022
Source: Bloomberg, as of August 31, 2022
Patience takes determination, resilience, and the confidence to stand by investments backed by careful, fundamental research. To be clear, being patient isn’t the same as being passive. It’s not about taking your eye off the ball and letting come what may. Nor is it about being too stubborn or inflexible to adjust one’s strategy when merited. Instead, the goal is to see past any noise in the market today and to hold steady in pursuit of greater rewards.
For the patient investor, those rewards are possible thanks to the power of long-term compounding. Our research indicates that successful companies plow profits back into their business to promote further growth, which can lead to greater value and higher stock prices over time. Investors who trade in and out of the market, whether driven by fear or to chase returns from the latest meme stock, frequently miss out on that compounding effect and sacrifice substantial long-term growth.
Taking the patient approach
At Polen, we believe that patient investing starts with adopting an owner’s mindset rather than that of a trader. For us, that means taking the time to identify and invest in what we see as the highest-quality companies and having the discipline to maintain those positions over the long term. We carefully study each company we invest in, engaging with their management teams and examining multiple aspects of their business before allocating capital. We take a bottom-up approach focused on understanding the business, its potential for profitability and growth, and any risk factors that could stand in the way.
Notably, the companies we invest in aren’t new, untested, or at the forefront of the latest fad or trend. They are proven, established businesses with robust balance sheets and the financial flexibility to keep investing in and growing their business in any environment, including periods of high volatility and recession. Once we’ve invested in a company, we continuously monitor its progress and note any factors that could prompt a change in our outlook (Exhibit 2). We believe that this measured, unemotional approach is critical not only for capital preservation but also to position ourselves to reap the full benefits of long-term compounding.
Exhibit 2: Select Factors That May Prompt a Polen Capital Decision to Sell an Equity Security
Source: Polen Capital
While no business is immune to macroeconomic conditions like the ones currently affecting the market, we believe short-term fluctuations shouldn’t be cause for concern. We believe that investors with a diversified portfolio of companies with outstanding fundamentals should reflect that while the path to wealth creation may be bumpy, the patience to play the infinite game can improve one’s chances of succeeding.
1 The Russell 1000® Growth Index is a market capitalization weighted index that measures the performance of the large-cap growth segment of the U.S. equity universe. It includes Russell 1000® Index companies with higher price-to-book ratios and higher forecasted growth values. The index is maintained by the FTSE Russell, a subsidiary of the London Stock Exchange Group. The Russell 2000® Growth Index is a market capitalization weighted index that measures the performance of the small-cap growth segment of the U.S. equity universe. It includes Russell 2000® Index companies with higher price/book ratios and higher forecasted growth values. The index is maintained by the FTSE Russell, a subsidiary of the London Stock Exchange Group. The volatility and other material characteristics of the indices referenced may be materially different from the performance achieved. In addition, the composite’s holdings may be materially different from those within the index. Indices are unmanaged and one cannot invest directly in an index.
This information is provided for illustrative purposes only. Opinions and views expressed constitute the judgment of Polen Capital as of September 2022 and may involve a number of assumptions and estimates which are not guaranteed, and are subject to change without notice or update. Although the information and any opinions or views given have been obtained from or based on sources believed to be reliable, no warranty or representation is made as to their correctness, completeness, or accuracy. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice, including any forward-looking estimates or statements which are based on certain expectations and assumptions. The views and strategies described may not be suitable for all clients. This document does not identify all the risks (direct or indirect) or other considerations which might be material to you when entering any financial transaction. Past performance does not guarantee future results and profitable results cannot be guaranteed.recession pandemic covid-19 ftse small-cap russell 2000 interest rates
Druckenmiller: “We Are In Deep Trouble… I Don’t Rule Out Something Really Bad”
Druckenmiller: "We Are In Deep Trouble… I Don’t Rule Out Something Really Bad"
For once, billionaire investor Stanley Druckenmiller did…
For once, billionaire investor Stanley Druckenmiller did not say anything even remotely controversial when he echoed what we (and Morgan Stanley) have been warning for a long time, and said the Fed's attempt to quickly unwind the excesses it itself built up over the past 13 years with its ultra easy monetary policy will end in tears for the U.S. economy.
“Our central case is a hard landing by the end of ’23,” Druckenmiller said at CNBC’s Delivering Alpha Investor Summit in New York City Wednesday. “I would be stunned if we don’t have recession in ’23. I don’t know the timing but certainly by the end of ’23. I will not be surprised if it’s not larger than the so called average garden variety.”
And the legendary investor, who has never had a down year in the markets, fears it could be something even worse. “I don’t rule out something really bad,” he said effectively repeating what we said in April that "Every Fed Hiking Cycle Ends With Default And Bankruptcy Of Governments, Banks And Investors" "
"Every Fed Hiking Cycle Ends With Default And Bankruptcy Of Governments, Banks And Investors" https://t.co/tfCHZMEkob— zerohedge (@zerohedge) April 16, 2022
He pointed to massive global quantitative easing that reached $30 trillion as what’s driving the looming recession: “Our central case is a hard landing by the end of next year", he said, adding that we have also had a bunch of myopic policies such as the Treasury running down the savings account, and Biden's irresponsible oil SPR drain.
Repeating something else even the rather slow "transitory bros" and "team MMT" know by now, Druckenmiller said he believes the extraordinary quantitative easing and zero interest rates over the past decade created an asset bubble.
“All those factors that cause a bull market, they’re not only stopping, they’re reversing every one of them,” Druckenmiller said. “We are in deep trouble.”
The Fed is now in the middle of its most aggressive pace of tightening since the 1980s. The central bank last week raised rates by three-quarters of a percentage point for a third straight time and pledged more hikes to beat inflation, triggering a big sell-off in risk assets. The S&P 500 has taken out its June low and reached a new bear market low Tuesday following a six-day losing streak.
Druckenmiller said the Fed made a policy error - as did we... repeatedly... last summer - when it came up with a “ridiculous theory of transitory,” thinking inflation was driven by supply chain and demand factors largely associated with the pandemic.
“When you make a mistake, you got to admit you’re wrong and move on that nine or 10 months, that they just sat there and bought $120 billion in bonds,” Druckenmiller said. “I think the repercussions of that are going to be with us for a long, long time.”
“You don’t even need to talk about Black Swans to be worried here. To me, the risk reward of owning assets doesn’t make a lot of sense,” Druckenmiller said.
Commenting on recent events, Druck was more upbeat, saying “I like everything I’m hearing out of the Fed and I hope they finish the job,” he said. Now, the tightening has to go all the way. “You have to slay the dragon.” The problem is that, as the BOE demonstrated with its QT to QE pivot today, it's impossible to slay the dragon and sooner or later every central banks fails.
What happens then? According to Druck, once people lose trust in central banks - which at this rate could happen in a few weeks or tomorrow - he expects a cryptocurrency renaissance, something which may already be starting...
... and not just there, but in the original crypto - gold - as well...
Excerpts from his interview below:
6 Best Stocks to Buy Right Now
The best stocks to buy right now are well below their highs. When the market rebounds, these stocks should move higher.
The post 6 Best Stocks to Buy Right…
With stocks dropping, it hurts to look at my portfolio. But on the other hand, I also get excited about the better buying opportunities. I can invest more money into great companies trading at lower valuations. That’s why I’m sharing some of the best stocks to buy right now.
With many investors heading for the hills, it’s not easy to stay the course and keep buying. But going against the crowd is the only way to beat average returns. So, let’s dig into these companies and why they’re towards the top of my buy list…
Best Stocks to Buy Right Now
- Intel (Nasdaq: INTC)
- British American Tobacco (NYSE: BTI)
- V.F. Corp (NYSE: VFC)
- Stanley Black & Decker (NYSE: SWK)
- FedEx (NYSE: FDX)
- 3M (NYSE: MMM)
As one of the best stocks to buy right now, Intel is in the midst of a huge turnaround. It’s one of the best semiconductor companies. Over the past few years, it’s lost some ground to competitors such as Advanced Micro Devices (Nasdaq: AMD). Although, Intel is in a stronger financial position to innovate.
Intel’s largest segment is its Client Computing Group. The pandemic helped push forward a lot of demand for these products. But recently, demand has slowed down. And Intel’s other segments have helped pick up some of the slack. Its next two largest segments are Datacenter and AI, and Network and Edge.
On top of that, Intel has talked about a Mobileye IPO. By taking this autonomous driving tech company public, it can free up cash for Intel’s big expansion. The company is under new management with CEO Pat Gelsinger. And he’s pushing to build new fab capacity.
Pat Gelsinger is also personally buying shares. He recently invested close to $500,000 and it’s a good sign when a CEO further aligns interest with investors.
British American Tobacco
This investment might not be for everyone. Many investors consider it a sin stock due to the products it sells. However, it also has a reliable consumer base that leads to consistent cashflows.
There’s increased regulatory risk, but investors are rewarded with higher dividend yields. And another benefit for a tobacco company is that its revenue remains fairly stable during economic downturns. This is great for income investors and the company provides some diversification…
British American Tobacco is based in London, England and for foreign investments, there can be taxes withheld from dividend income. However, the U.K. doesn’t withhold dividend taxes for U.S. investors.
V.F. Corp is one of the smaller stocks to buy right now when looking at market cap. However, it owns some huge brands such as The North Face, Vans and Timberland.
Its diverse portfolio has helped the company produce stable cashflows. As a result, the board of directors keeps paying investors bigger dividends. V.F. Corp is a dividend aristocrat and that means it’s paid a larger dividend each year for the past 25 years in a row.
Similar to the others on this list, VF stock is down a lot over the past year. Investors are worried sales will drop as consumer spending drops. However, it’s during these downturns when some of the best buying opportunities come along. V.F. Corp should be able to weather a downturn and continue rewarding long-term investors.
Stanley Black & Decker
Stanley Black & Decker is around the same size as V.F. Corp. Although, it’s in a very different industry. Stanley Black & Decker builds industrial tools and household hardware. It also provides security products.
This company also has a long history of rewarding investors with larger dividends. It’s a dividend aristocrat and the dividend looks pretty safe. Its recent payout ratio comes in below 60%.
As one of the best stocks to buy right now, Stanley Black & Decker is also trading at a lower price. Its valuation metrics have come down and the company should easily survive through a recession.
FedEx is a leading transportation, e-commerce and business services company. It’s focused on long-term growth and building economies of scale. FedEx delivers to more than 220 countries and territories.
Thanks to growing cashflows, FedEx has also been rewarding investors with bigger dividends each year. On top of that, the recent dividend payout ratio is low with it coming in well below 50%. This provides good wiggle room as the economy takes a hit…
The CEO of FedEx recently said that he expects the economy to enter a worldwide recession. This will put downward pressure on FedEx’s sales and profitability. Although, investors have beaten down the share price and the company should be able to continue rewarding long-term investors.
3M is last on this list of the best stocks to buy right now. Investors have pushed down its share price due to litigation risk from some of its past products. And the company has roughly 60,000 different products, so it’s not new to legal troubles.
Although, fear is high for investors due to recent actions. As a result, 3M shares are likely oversold and the risk-to-reward is looking solid.
Similar to the other companies on this list, 3M has a long track record of rewarding investors. It’s also a dividend aristocrat and for long-term investors, right now might be one of the better buying opportunities.
More Investing Opportunities
There are thousands of different investments to choose from. However, I believe this list provides some of the best stocks to buy right now. All of these companies come with a different set of risks and the markets might continue to drop. So, always do your own homework, and consider both your ability and willingness to invest.
If you’re looking for more investing insight, check out these best investment newsletters. They’re packed with tips and tricks from investing experts. Here at Investment U, we strive to deliver the best investment research and ideas…recession pandemic nasdaq stocks consumer spending
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