Quality small caps, recession, FTX and Eugene Fama - the best investing blogs and podcasts from the past week
An interesting dynamic in this year’s stock market sell-off is that one of the causes hasn’t even (officially) started yet.
Eighteen months of high and rising inflation has been brutal on company costs and customer demand. But on that front at least, it seems likely that one (or two) things will soon happen.
One is that companies will continue to adjust to it (by absorbing or passing on higher costs), and the other is that inflation will fall quite soon. Both seem plausible.
But neither of those can change the fact that inflation and the rising interest rates employed to fight it are a leading indicator of a looming recession.
A good part of this year’s market tumble is going to be the pricing-in of that recession. Everyone knows there is more trouble ahead for companies.
I love this Vanguard chart that shows how the market historically prices in recessions before they happen and starts recovering before they’re officially over.
As for now, no-one really knows what a recession will look like or how it might affect firms. Some misery is certainly priced in, but is it enough?
Andrew Bailey, the Governor of the Bank of England, has suggested it won’t be as deep as the financial crisis recession of 2008. But it might be longer. Perhaps two years. But given that it took three years to recover from the downturn that hit us in 2008, it’s hard to feel comfortable about all this.
With this kind of backdrop, a lot of what I’ve been reading (and writing) lately has been about quality: profitability, dependability, strength in a crisis, that kind of thing.
Faced with these conditions, studies show that investors lean towards safer strategies like high dividend yield, low volatility and quality… and small caps…
Hang on. Small caps?
Well, maybe not quite what UK investors would class as ‘small’, but a recent note from the American asset manager GMO, suggests that ‘small’ in the context of the US market is currently ideal territory to go looking for high quality at good prices.
GMO is very much a value-driven investor, so it’s interesting that they are saying this now.
The article is a bit of an advert for the fund, but their views on the space are interesting: that basically you’ve got to forget about narratives and lottery-like investing and focus instead on quality basics.
Their preferred metrics are strong and stable profitability, high return on capital (and equity), good capital allocation and low debt. All the essentials. Note that the benchmark for GMO’s quality small-cap fund is the S&P 600. That has a market cap range of $850 million to $3.7 billion, which sits closer to what you might find in the FTSE 250 here in the UK.
All the same, it's still a vote of confidence in smaller firms. I did a rough and ready quality small-cap screen for AIM companies and there are surprising numbers of high quality firms on that market that have seen some really substantial P/E declines in 2022 - all of them forecast to see earnings grow in the next couple of years.
There is no doubt there seems to be cheap quality out there among the small-caps. We just need to be able to see past the recession…
I heard about this on the Value After Hours podcast: Small Quality Value Crushing It
The GMO link is here: Quality Time in Small Cap
If you don’t want to fight the registration box, you should be able to get the downloaded article here
Top posts from the past week
Vox Markets Fund Manager Series - Q&A with Amati Global Investors fund manager, Dr Paul Jourdan
For more on the state of the market and what’s really driving prices, this interview with Paul Jourdan is good value. Paul runs the smaller companies fund at Amati Global. He’s pragmatic on geopolitics, not a fan of crypto whatsoever (‘tulip bubble’), and Paul Hill runs him through 16 small-caps that are in his fund at the moment.
Small Caps Podcast with Paul Scott - Episode 20
Another podcast with a UK small-cap focus worth a listen in Paul Scott’s weekly round-up. As always he finishes with some interesting macro views on inflation, market direction and government policy (after 28 minutes), but before that he mentions…
Joules (LON:JOUL), Loungers (LON:LGRS), Appreciate (LON:APP), house builders, Marks Electrical (LON:MRK), Hilton Food (LON:HFG), Warehouse REIT (LON:WHR), Volex (LON:VLX), Smiths News (LON:SNWS), B&M Retail (LON:BME), Virgin Wines (LON:VINO) and Norcros (LON:NXR).
Meb Faber Show Podcast - Episode #455: Eugene Fama: A Life in Finance
Eugene Fama is pretty much the closest you get to finance royalty, especially when it comes to portfolio management. His long career in academia saw him win the Nobel prize in 2013 for his work on asset pricing. He’s a proponent of the efficient market hypothesis, and was involved in developing multi-factor models of what drive investment returns - including the influential value factor. At one point in this discussion Meb asks him to estimate how much money he thinks has been managed by his former students - and the answer is in the trillions. But in terms of his own view, Fama is much more of an advocate of owning the global market portfolio as a starting point and then talking yourself out of it. Overall, he’s a legend, so it’s worth a listen just for that.
A Long Time In Finance - The Last Days of Crypto
The collapse of the huge cryptocurrency exchange FTX, and the jaw-dropping stories emerging from it, are likely to reverberate for a long while. For some, it represents an existential crisis for crypto, and for others it’s yet another ‘I told you so’ moment. But as the stories of hopeless controls and governance, crazy Bahamian penthouse pads and private jets emerge, what really will happen next? If you want to catch up with what all this means, with a discussion that breaks down what FTX was really all about and what the future holds for crypto, this podcast with Jonathan Ford, Neil Collins and Izabella Kaminska is a great start.
For even more fiery views on crypto and blockchain (and more), you could do worse than listen to this CNBC interview with Charlie Munger - Charlie Munger: Berkshire, Billionaires, & the Blockchain
Have a great weekend!
Ben
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