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"It's Almost Time to Buy Small-Caps"

David_Snowball
in Fund Discussions
So declares Spencer Jakab, a WSJ writer, in the October 11 WSJ.

His argument is that small caps are historically undervalued relative to large caps: "the ratio of the Russell 2000 to the Russell 100 index, which has moved between a low of 58% ... to a high of around 115% ... is back down to 74%, indicating a fairly stressed level." At the same time he admits headwinds: small caps are far more exposed to interest rate changes than are large caps. Their debt is more likely floating than fixed and the average maturity on their debt is 4.4 years versus twice that for large caps.

Why consider them? Small caps have outperformed large caps, by an average of 16.51%, coming out of every one of the past 11 recessions. (SJ's wording is odd here: "in the 12 months after a recession was declared every time." The Lords of Finance generally officially declare a recession about eight months after it ends.)

In particular, small value is a good place to be. Focusing on small-value "could have the added benefit of supercharging returns during a recovery. For example, the years 2001-2004 saw $100 investing in the S&P 500 turn into about $98 which an investment in the Russell 2000 Value grew to $180."

The "almost" is the "they do well after a recession but suffer during one" part, I would guess.

My own exposure to the small cap sub-class is divided between the ultra-cautious Palm Valley Capital (micro-cap value, $250M AUM, 13% invested in stocks, up 5.3% YTD) and the ultra-charged Grandeur Peak Global Micro (micro-cap growth, soft-closed with $41M AUM, fully invested, down 2% YTD, but top 1% over five years).

Comments

  • MikeMMikeM
    Almost:) Not sure what that means.

    I now have to much cash after transferring much of my Schwab robo to my self managed account. I've started to add some of that cash to my small cap fund, QRSVX.
  • Devo
    Scott Barbee's investor letters are a must read for small cap investors. True, there are a lot more names in that category now and thus better pickings. False, that these or any other stocks wont get penalized if the broader market turns south. Sometimes, it feels like the only time to get long all these high beta assets is when they have crashed. They are not up, but have they crashed. Not sure.
  • ShostakovichShostakovich
    I'm always about 10-15% smid caps, with a heavy value tilt. Especially in my Roth where I have longer (God willing) to ride out any recession. Small caps rock !
  • hank
    edited October 2023
    I saw the ”$250M AUM” and at first (incorrectly) read that as the fund’s ”minimum investment amount”. I thought to myself, Hey - David’s not doing too badly.;)
  • BenWPBenWP
    I have also been reading about the possible SC revival. With respect to the indebtedness of many small companies, I am persuaded by the managers at Distillate Capital, whose SMID fund, DSMC, purposefully avoids stocks of firms that carry excessive debt. DSMC performance is not in the least bit shabby, although the fund does not have a long history. DSTL, however, has firmly established itself in the LC arena. Article linked:

    https://distillatecapital.com/wp-content/uploads/2023/10/Small-Stocks-Debt.pdf
  • BennyB
    I sure hope small caps go up and soon!!!! Ive owned WAAEX for years-held on too long I think- Ill just say its downhill racer!!
  • WABACWABAC
    edited October 2023
    RWJ ticks the SCV box for me. FMIMX is smidish, and valueish by P/E. XMHQ is my other smidish.

    CALF is an interesting alternative to RWJ. I am keeping my eye on it.

    I have no idea why funds weighted on revenue, or cash-flow yield, should end up in the value box, but there they are.

    I have owned VSIAX for many years. Sold out in the IRA for investments named above. And probably soon to be sold out in the taxable for same. It doesn't seem to do anything very well in any conditions compared to funds based on the S&P 600 and 400.

    I have owned other small caps in the past, like QRSVX and RYSEX. NBGNX was the best of those funds in those days.

    I had a nice run with HSCSX while Teach and Morris were part of the team. Sold that after Ashton left because it was already fading in comparison to its peers. One of the best sales I have made.

    Going back to the OP, I guess I can say it has always been time for me to hold small caps.
  • yogibearbullyogibearbull
    A rare 2nd DEATH-CROSS for small-cap R2000/IWM today. 1st was in April.

    There were high hopes for GOLDEN-CROSSES that turned out to be false in January and July.

    The same is also seem for better index SP SC 600 (IJR, SPSM).

    Bright side may be - but how much worse can it be? Or, it is in giant trading range since 2022.

    https://stockcharts.com/h-sc/ui?s=_IWM&p=D&st=2023-01-01&id=p37153942767

  • CrashCrash
    Small? too volatile for me, now. The small stuff I own is because the fund managers decided to do it. 13% of total equities, and 9% of that is VALUE. OOPS, maybe some of my single-stock choices are in that mix. I own only 5.
  • Observant1
    edited October 2023
    From Jan. 2001 through Dec. 2011, the Russell 2000 and S&P 600 significantly outperformed the S&P 500*.
    https://www.portfoliovisualizer.com/backtest-portfolio?s=y&sl=qEr2lFXVGTW5gNPWAJxWs

    From Jan. 2012 through Dec. 2022, the S&P 500 outperformed the Russell 2000 and S&P 600
    by ~3% and ~1.5% respectively.
    https://www.portfoliovisualizer.com/backtest-portfolio?s=y&sl=5g0Yk5t9TsoeVvUGo6maDY

    The small-cap indexes generated higher returns than the S&P 500 over the full period.
    https://www.portfoliovisualizer.com/backtest-portfolio?s=y&sl=7HwyrroGKk5DAqntFXirk6

    Most of my small-cap exposure is via VTMSX which I've owned for over a decade.
    I'd welcome a small-cap rally!



    * IWM represents Russell 2000, IJR represents S&P 600, VFINX represents S&P 500
  • Sven
    edited October 2023
    This year is challenging for smaller cap funds when the broader index is dominated by the large tech stocks. Only one out three, FMIMX, did decently, the rest trailed considerably. So we pause until the market broaden out. Not indexing in the smaller caps for us as many small stocks are not profitable.
  • yogibearbullyogibearbull
    edited October 2023
    @Sven, that is the main problem of nonselective/comprehensive indexes such as R2000/IWM and extended market/VXF. They include almost 40% SCs that are losing money.

    IJR, SPSM are better SC indexes. Also active SC funds should avoid this problem but find one with reasonable ER.
  • Observant1
    edited October 2023
    Sven said:

    This year is challenging for smaller cap funds when the broader index is dominated by the large tech stocks. Only one out three, FMIMX, did decently, the rest trailed considerably. So we pause until the market broaden out. Not indexing in the smaller caps for us as many small stocks are not profitable.


    The Russell 2000 index contains many stocks which are unprofitable.
    "The small cap market is fraught with landmines – weak companies that have been able to survive in this era of easy money; at the end of 2022 approximately 40% of companies in the Russell 2000 Index were unprofitable."
    https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/market-updates/on-the-minds-of-investors/is-there-an-opportunity-in-small-caps/

    There is a profitability screen for S&P 600 index inclusion.
    "Financial Viability: Companies must have positive as-reported earnings over the most recent quarter, as well as over the most recent four quarters (summed together)."
    PDF


  • Sven
    My limited experience with small cap indexes have less than satisfactory, but will track IJR and SPSM as you recommended. Right now, small caps are far from being “fat pitches”, at least for us.
  • WABACWABAC
    Worth noting here, perhaps, Invesco recently converted its equal-weight 400 fund to the GARP model used by their SPGP fund. So EWMC is now GRPM.

    This sort of turnover in strategies makes tracking etf's interesting.

    But why weight with the dogs in this environment?

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