It looks pretty gloomy out there for index fund investors after the worst September in 20 years, but with the Fed tightening and real earnings growth failing to keep up with inflation, there’s a reason confidence has cratered.
With that in mind, it’s a good thing we aren’t index fund investors. Dive beneath the surface and a lot of stocks are in a much better place . . . expanding fast enough to defy the economic weather and outperform the status quo.
That’s a big deal when the status quo looks lousy. Investors starved for good news will jump to make room in their portfolios when they see it.
I’ll be highlighting a few of the top names on my screen at the virtual MoneyShow on Tuesday You’re welcome to attend. It’s free. And it’ll give you a better sense of the opportunities in the market and how I find them. Interested? Click here to register.
After all, this is a great time for fresh leadership. The Wall Street establishment is tired and mentally out of shape. The future belongs to small investors like us with insight, experience and the courage of our convictions.
The Future Favors The Bold
My old rule of thumb was that every time interest rates drop 0.25 percentage point, the ceiling on the S&P 500 moved about 3% higher. Now, the Fed moving in the other direction is a pretty good ceiling is getting closer with every policy meeting.
And the market as a whole doesn’t exactly look cheap here at 15.8X projected earnings. It’s hard to pay that price in the absence of concrete good news . . . after all, all the data points say the economy is humming along, but inflation ensures that it doesn’t feel anything but miserable.
Meanwhile, the analysts have fallen down on the job. They cover their companies admirably, but they retreated into a herd mentality in the pandemic environment when the Fed was our friend and every stock was surfing the free money wave.
The bigger the stock, the more crucial it is for every bank and brokerage firm to cover it. Giants like Amazon (AMZN) and Alphabet (GOOG) have 40-50 of the smartest people on Wall Street watching their every move.
But go down the food chain and coverage drops off fast. For the S&P 500 as a whole, average coverage drops to about 20 analysts . . . and at the low end, companies like Vornado (VNO) and Penn Entertainment (PENN) barely have 10-15 people running the numbers and showing up at the conference calls.
These are still big companies, worth $3-5 billion apiece. Forecasting their moves accurately can still make a lot of shareholders a lot of money . . . or leave them shut out in the cold when the models don’t match reality.
And then you go a step even lower on the chain. A typical mid-cap company barely rates 7 analysts these days. Classic small-cap stocks might get 4-5 people at most following them.
When Wall Street cuts back, it cuts coverage on these names. And as a result, their dynamism gets ignored . . . by all but those who keep their own eyes open and refuse to settle for “whisper numbers.”
Small Is Beautiful
Right now small stocks trade at a 7% discount in terms of raw earnings. Normally they command a 20% premium because they’re where the long-term growth is.
If we’re lucky, the S&P 500 will close out 2022 at a trailing P/E of maybe 17. Smaller stocks currently trade at under 13X current earnings. People simply forgot about them in the pandemic.
And it’s not like the pandemic killed these companies either. I’m looking for mid-cap stocks to boost their bottom line at least 15% this year . . . after doubling their earnings last year. They’re back from COVID and they’re roaring.
True small-cap stocks (under $2 billion) have had a slightly more challenging time, but even they’re flashing 12-13% growth on average this year.
Put that in context: the S&P 500 as a whole is going to be lucky to deliver a fraction of a point of positive growth this year. Factor out Big Oil and the trend turns negative.
Those stocks are already in an earnings recession as of last quarter. Whether they recover or not, I’d much rather be where the clear growth is available at a reasonable price.
But that requires doing a little more homework. You have to pick your spots more carefully. If Exxon (XOM) looks expensive, start screening for small and obscure energy companies.
We’ve done well with ProFrac (PFHC) and Excelerate Energy (EE) lately. One look at those charts should convince any investor that there’s room to cheer even in this environment.
You just have to reach for it. I hope you’ll be in the crowd on Tuesday. (Click here to reserve your virtual seat.)
Otherwise, hang in there. The index funds will recover . . . but we’re going to need either a spectacular earnings season or a couple of months more patience to see it happen.