Small Cap Investing in Volatile Markets

TRANSCRIPT

For example, companies likeQuidel or Everbridge. I know we hear a lot of rhetoric, but when people say earnings are going to go down, or going to be negative, they just refer to the S&P 500. But we’re not investing in S&P 500 companies, right? We believe a lot of companies that we invest in, even software companies, are still going to grow. They will have selling activity, but they’re still going to have positive earnings. Our job is to see what is priced in. That’s why we talk to every single one of our companies now, right?And we look at our models. We separate companies that have earnings risk and then don’t have earnings risk. Then the companies who have earnings risk, we want to see how much is that priced in? Then it’s really about positioning. We’re not going to sell everything that’s going to have a soft Q1, right, because it’s just going to be a bump in the road. There’s a lot of stress testing going on for us now, so it’s really company by company. And it’s very hard to say how long it will last, right, but eventually it will pass. BN: I’ll just chime in from a broader market perspective. I think consensus right now is that the first half earnings to clients materially and GDP, and then some people are looking for a bounce-back in the second half of the year in terms of GDP. From my perspective, I would not comment on when the bounce-back would be. My view is that when the markets get comfortable that virus transmission is slowing and therefore the end is forecastable, the attention will shift from how bad earnings are this year and they’re going to be, I think, pretty bad in the 1st and 2nd quarter to what are more normalized earnings in 2021. I don’t think it’s exactly about when GDP starts coming back, but I think it’s about when there’s more ability to look forward in time. And what we’re watching on that, what I’m watching on that, is the individual country curves of virus transmission.

You’ve seen China, Korea, and a couple of other countries flatten that curve and Italy is one we’re watching very closely. There may be some tentative signs that that exponential growth is slowing. And I think what the market just needs to get comfortable with is exponential growth starts to slow, becomes linear, and flatten off and then the shift will be towards 2021. Earnings were $162 last year and they’re going to drop to some number in 2020. The question is: how do you value the stock market? What earnings number for 2021 do you use? Speaker Question: My question is more on the general market as a whole. You know, small caps have underperformed for the last year-and-a-half to two years and have been underperforming in general as the market has gone down here. What do you see as a catalyst for small caps starting tooutperform and what is that time frame? AZ: Small caps have underperformed large caps since the end of 2013, right? So, I think a lot of this perception, because when people think about small caps, they think it’s riskier. It’s not in my opinion. They think about, you know, lower financial quality. But also, small caps as an asset class have become much more attractive because they are more U.S.- centric. When you look at any bounce-back, nobody knows when exactly it’s going to bounce-back. You could look at 2008 to 2009 when there was a very sharp rebound. I think small caps will benefit tremendously because I will still want to be more U.S.-centric at this point because I think the damage this coronavirus has done to Europe and to China, the economic activity is a lot much more than U.S. In the U.S., we’re still in the cutting edge of innovation. We are a service economy and we are not manufacturing driven.