Size effect, bear markets, Ted Seides and value investing - the best investing blogs and podcasts from the past week
Hello, here’s this week’s Fully Invested newsletter. What a week it’s been here in the UK, and one that’s ending on a sad note. Not everyone is a fan of the royal family, and sometimes for pretty understandable reasons. But the Queen was definitely a positive force, and it’s surprisingly unsettling to not have that any more.
As a routine reminder, this weekly newsletter gets you:
A curated collection of the best things I’ve read and listened to (or seen) this week when it comes to the stock market
Some of my own thinking, which almost always kicks around investing themes and strategy
A much fuller link-list, which is also checked over (I try very hard to keep the quality high, even if it doesn’t all appeal to everyone)
I’m thinking of expanding the newsletter to include more practical guides for DIY investors. But in the meantime, if there is anything you’d like to see (or see less of), or you think would be really useful, either here or in supplementary articles, give me a shout.
Jim Slater, the City financier and inspiration to a generation of growth stock investors, once wrote in his book, The Zulu Principle, that “elephants don’t gallop”.
In his buccaneering pursuit of companies with the potential to re-rate dramatically, Slater was pretty dogmatic in his view on where to find them. Smaller companies with the right blend of appealing valuation, good growth and positive price momentum were where the big prizes could be found. Larger companies that were at the mature end of their growth cycles just couldn’t offer the same kind of punch.
According to the data, Slater wasn’t wrong: small-caps do tend to outperform large-caps over time.
The ‘size effect’ was first observed by the academic Rolf Banz in the early 1980s. Ten years later it became one of the main strands (known as ‘small minus big’) in the massively influential three-factor pricing model developed by Eugene Fama and Ken French.
In terms of performance, the size effect has been pretty sticky…
Between 1955 and 2019, the total return of the UK-focused Numis Smaller Companies Index (excluding Investment Companies) beat the FTSE All-Share by 3.3% per annum. That index is a popular small-cap benchmark with British fund managers. The average market-cap of companies in it was around £375 million in 2020.
In the US small-caps tend to mean something slightly different (bigger). The Russell 2000 ‘small cap’ index, for instance, has market caps that range from $50 million to $25 billion. The median is just over $1bn. But even so, Fama/French data shows that smaller stocks have outperformed by around two percentage points annualised since 1927.
So the size effect has historically had an influential role in returns. Yet anyone watching markets this year will know that small-caps have had a terrible time. The Numis Smaller Companies + AIM (ex-ITs) index, for example, is down by 21.8% this year. And that’s a nod to the fact that while you might get a better performance out of smaller company shares on average over time, they come with a lot more volatility than large caps.
The reality is that smaller companies are generally more vulnerable to a deteriorating economic outlook, especially one where inflation (and rising input prices) is playing a role.
Yet despite the hellish conditions for small-cap investors this year, there could be reasons to be cheerful. Research by Dan Rasmussen and his colleagues at Verdad shows that the size effect has basically been absent in the US market for a decade. But the upshot is that small-caps are now trading at a discount to large-caps not seen for 50 years. Basically, they’re cheap - and that’s a strong signal.
Small Cap Relative Discount and 10Y FWD Relative Returns
Source: Verdad
Rasmussen reckons that in recent history there have been only two occasions when small-caps were more expensive than large-caps. One was the 1980s and the other was during the 2010s. In each case, those periods saw small-caps tend to underperform. But then as they got cheaper than average, the performance flipped and small-caps outperformed in the next decade. And that’s where we are.
If history rhymes with the past, it looks like small caps could be the place to be as and when conditions improve.
You can read the Verdad note here: The Size Factor. There was also a Value After Hours podcast on it here: Small Caps are Due
Top posts this week
Paul Scott - Small Caps Podcast – Episode 10
It’s been an incredibly tough year for international small-cap shares, and European ones in particular. The MSCI Europe Small Cap index was down 30% in the first eight months of the year, and the World Small Cap index was down 18%. So the views of commentators like Paul are super helpful for investors feeling that pain. This podcast covers some recent company updates, but his macro analysis is just as useful. At 22 minutes he moves on to spiralling energy costs in the UK, and the impact that’s having on companies and sectors. It looks like huge numbers of firms are at risk of going out of business without government action, potentially on the scale of what we saw in the Covid crisis. Companies themselves need to be upfront about how they’re being affected by these rising costs. But it’s not all bad news. The small-cap sell-off has been painful, but it could pave the way for major upside in the recovery. Paul points to two elements to look for in companies right now: pricing power and the ability to pass on price rises, as well as products that are either non-discretionary (those that customers need to keep buying) or value for money (those that customers are seeking out).
Quality Share Surfer - Bear market resumed
Last mentioned here on 29 July, this is the latest portfolio review from Quality Share Surfer, whose blog documents the adventures of a quality/growth strategy. Early signs of improving market conditions in recent weeks now look like they were just a bear market rally. That forced some quick profit taking on earlier trades. Among the stocks joining the portfolio were Moncler (MONC) and Canada Goose (GOOS), together with PepsiCo (PEP), Fonix Mobile (FNX) and Celsius (CELH).
There was also a new post from Compound Income - End of Summer update, which is another portfolio I like to keep an eye on. Again, a return to bearish conditions has made life tricky in an already difficult year, but that ‘quality plus value plus yield’ strategy has very much outperformed in recent years.
Opto Sessions - How Capital Allocators host Ted Seides interviews asset managers (also at Capital Allocators - Insights on Investing and Podcasting)
I sometimes feel like it’s a bit of a red flag when podcast hosts interview other podcast hosts, but there’s nothing to fear here. Opto, the investment hub run by CMC Markets, has one of the best UK podcasts on investing. This one was actually done in mid-August, but it’s worth a mention because Ted Seides is a very interesting guy. He’s an ex-hedge fund investor (he once had a very public wager with Warren Buffett over the performance of hedge funds versus the market). But more broadly, this conversation takes in his experiences in markets dating back to before the dotcom boom. He also talks about some of his own interviewees, including Sam Zell and Joel Greenblatt. It’s an easy listen with a lot to take away and some interesting ideas. It’s definitely worth an hour of your time.
Jeremy Grantham, GMO - Entering the Superbubble’s Final Act and Frank Martin - The Taxonomy of Bear Markets
Jeremy Grantham, the boss of the value-focused US asset manager GMO, has been warning for months about the risk that equity markets have been in a superbubble. He reckons the pressure we’re seeing on prices could be just the start of a major unwinding. That might be true, but these kinds of warnings have been coming for a while. And while Grantham has got these calls right in the past, his strategies (and those of anyone that gets their timing right) would really benefit from the uplift following a serious collapse. So caution is needed. That’s why I’ve also included the post from Frank Martin, which is no less bearish really, but takes a slightly different look at how things might develop and what the drivers are. Both articles are US-centric but the issues are similar to those facing the UK market and affecting UK investors.
Meb Faber Research - Episode #441: Marlena Lee, Dimensional Fund Advisors – Value, Fama & Weathering
I’ve been mentioning Meb Faber a lot in Fully Invested recently, so I’ll give you a brief explainer about him. Meb runs Cambria Funds, which is his own money management business (mostly ETFs) in Los Angeles. He’s been very vocal in the industry for years, and that’s evolved into something of a publishing machine. He hosts video interviews on a weekly basis, and definitely part of the appeal is his super-chilled Californian vibe. I’m trying to be picky about which of these conversations I flag-up, but this one is good. Dimensional Fund Advisors is a massive value-focused fund manager with ties to Eugene Fama (an architect of modern value investing). DFA is interesting in itself because it’s had an unusual focus on price-to-book as its preferred measure of value. All of this becomes clear in this conversation with Marlena Lee, who is excellent at explaining some of this stuff. Often these interviews by Meb are targeted at industry people, and it does go that way in the second half. But if like me you’ve got a nerdy interest in things like value, it’s an interesting chat. The conversation mention an article from Marlena from earlier this summer, which is here: Three Crucial Lessons for Weathering the Stock Market’s Storm
Have a great weekend - you can find the usual list of the best of the rest investment blogs and podcasts is below…
Ben
Thinking & Strategy (Blogs)
Back to my favourite topic in Italian economics…
Klement on Investing
Brand Values and Long-Term Stock Returns
Alpha Architect
The Anatomy of Power — John Kenneth Galbraith on Conditioning and Organization
Athenarium
Reality is Messier Than Spreadsheets
A Wealth of Common Sense
Good Enough
Morgan Housel
The Learning Mindset for Investors with Alix Pasquet
Neckar's Minds and Markets
UK Top 40 High-Yield Blue-Chip Stocks: 2022 Q3
UK Dividend Stocks Blog
The Simple Value Investing Formula That Makes Everything Clear
Behavioral Value Investor
How to Get More Time
Of Dollars And Data
Passive vs active investing: why passive wins
Investing Archives - Monevator
Why is Active Fund Selection So Difficult?
Behavioural Investment
Pandemic, Recession, Roaring Twenties… Repeat?
Investor Amnesia
Mirror, Mirror on the Wall, Which is the Fairest Benchmark of Them All?FactorResearch
9-Chart Sunday (9/4/22)
Compound Advisors
Thinking & Strategy (Podcasts)
Putting the Right Price On Time
A Long Time In Finance
Making Big Gains In Bear Markets (w./ Christian Putz)
Capital Employed FM
Show Us Your Portfolio: Ryan Krueger
Excess Returns
Will Storr—The Status Game (EP.122)
Infinite Loops
Mitch Lasky - The Business of Gaming - [Invest Like the Best, EP.293]
Invest Like the Best with Patrick O'Shaughnessy
#146 Barbara Tversky: Action Shapes Thought
The Knowledge Project with Shane Parrish
Securities & Markets (Blogs)
Small Caps Live Weekly Summary(ish)
Small Caps Life
The Services iPhone
Stratechery by Ben Thompson
PANIC JOURNAL – UKRAINE/RUSSIA EDITION PART 4: The new “Freedom Insulation” Basket
value and opportunity
IMARA: Asset Sale, Below NCAV, Potential Liquidation
Clark Street Value
Weak pound means opportunity for AIM’s exporters
Fundamental Asset Management
September 2022 Stock Considerations
DivHut
What will Liz Truss mean for the stock market? Investing Show
Investing | Mail Online
Gold Miners Trading At Dirt Cheap Prices… [DIRTY DOZEN]
Macro Ops: Unparalleled Investing Research
Securities & Markets (Podcasts)
The Battle to Remain Bullish
The Reformed Broker
Tough to Beat the Market
The Big Picture
The Value Perspective Podcast episode – with Robert Bryce
The Value Perspective
Quixant (QXT) 2022 interim results presentation – September 2022
PIWORLD
The Companies & Markets Show: Emerging markets, Hargreaves' charges and Top 50 Funds
Investors' Chronicle
Scottish Mortgage fund manager grilled, investors react to new UK Prime Minister, and FTSE 100 stocks with best dividend yields
AJ Bell Money & Markets
TWIN PETES INVESTING Podcast no.83 with LIVE in person video
TWIN PETES INVESTING | Conkers3
Bed Bath & Beyond Belief
Stock Club
The Enduring Benefit of Running Permanent Capital Vehicles with Craig Packer, CEO of Owl Rock Capital Corporation (NYSE: ORCC)
Compounders: The Anatomy of a Multibagger
E100 - Marshalls, Bunzl, Plus500, Gamma Communications, Aston Martin Lagonda & Wix
The Investor Way
AMD: How Chips Are Changing - [Business Breakdowns, EP. 73]
Business Breakdowns
Weekly Investment Trust Podcast with Jonathan Davis (03 Sep 2022)
Money Makers
Small Caps Podcast with Paul Scott – Episode 10
Quality Small Caps