I’ve been sweating on a small cap revival and Jerome Powell’s talk about rate cuts makes me confident that I’m right.
When you get individual stocks wrong like CSL and James Hardie, it’s comforting to know that they were small plays in a wider a portfolio which is overall heading in the right direction. It’s why I like ETFs and at least 15 stocks to form the core or the base of my SMSF’s stock of shares.
And it’s more comforting when your bigger plays have been and are still heading in the right direction
For me and my clients, we have long VAS, which is the top 300 stocks in local market, VHY, which gives income and IHVV for a broad exposure to the S&P 500 for the US stock market.
Along the way, we’ve tapped into the likes of GEAR, which gave us leverage, when the S&P/ASX 200 looked too low and set to rise. And then HNDQ for exposure to the top 100 stocks on the tech-heavy Nasdaq, which gave us the uplift from the Magnificent 7 stocks that have ‘wowed’ them for three years.
Being an adviser not a punter, we’re now out of GEAR and HNDQ. Even though we got out a little early, I’d rather bank profit, especially when you have the most unpredictable US President ever!
My latest themed play that I’ve been sharing with you has been EX20 from Beta Shares that gives us an exposure to the stocks numbered 21 to 200. This is because I’ve argued as interest rates fell, quality small and mid-cap companies badly affected by higher interest rates were likely to do well.
For the year, EX20 is up 13.07%. I’d argue this is only the start of the interest rate cut rotation out of big cap stocks, such as the banks, that fared well as rates rose. Now it’s the time for companies that will do well with lower rates.
And Jerome Powell’s utterances from the Jackson Hole conference in Wyoming (USA) has not only excited Wall Street, with all four market indexes up strongly on Friday, it’s bound to help our stock market and the likes of EX20, as well as small cap fund managers who are always on the lookout for companies yearning for lower interest rates.
It’s no coincidence that the likes of ZIP and Tyro, which use borrowed funds to bankroll their payments businesses, have seen big spikes in their share prices recently.
ZIP is up 65% in the past year. While Tyro was late to the party, it has risen 35% in the past six months, with allegedly two potential buyers browsing. If this is true, it surely would be related to a view that as rates fall, interest costs fall, the economy picks up, consumers spend more and payments businesses benefit. If all the above analysis is right, then payments companies will be more valuable in the future.
That’s why buyers of these stocks and the businesses themselves look more buyable.
On Friday, while I thought it significant that the Dow rose 1.89%, the S&P 500 popped 1.52% and the Nasdaq spiked 1.88%, the small cap Russell 2000 surged big time, rising a whopping 3.86% in one day!
Reinforcing my long-held positive view on the potential for smaller cap stocks as rates fall was the reaction from Tom Lee, head of research as Fundstrat Global Advisors, to what Jerone Powell told the central bankers at Jackson Hole. “The Fed acknowledging that the risks now are tilted to the labor market to be softening … especially because they don’t think that tight labor markets are going to create inflation, that’s a very good sign,” Lee told CNBC. “I think it means we have a dovish Fed again —that’s kind of a green light for small caps.”
The Russell 2000 gave credibility to Lee and my calls that it’s time for smaller cap plays. This was all helped by Powell implying concerns about the job market are starting to rise as inflation is slightly less worrying.
Of course, while a tariff effect on inflation is likely, many argue that it will be more of a one-off rise. And a weakening labour market will prevent any new inflation becoming entrenched as we saw after the Covid lockdown.
Given all this, I’ll be looking at the best-performing small cap managed funds, such Eley Griffiths EGG Small Companies Fund, which was up 15.12% to July this year. Then there’s a local Vanguard MSCI Australian Small Companies Index ETF (VSO) that did over 17% in the year to July.
And if you want to try overseas, there’s the Vanguard MSCI International Small Companies Index ETF (VISM), which was up around 10% for the year.
The bottom line is thinking small with funds that have a big collection of companies that will benefit from lower interest rates looks like the right play for now.
One final point. The small cap play doesn’t last forever because VSO’s long-term return is 6.68%. When a stock market slumps, small cap funds can register big negatives.
So, watch this space! I certainly hope we can warn you about the right time to lighten your load of small caps.