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ITPM Flash Ep26 Revenge of the Small Caps

ITPM Flash Ep26: Revenge of the Small Caps

Summary - Revenge of the Small-Caps

  1. Discussion on the potential outlook for small-cap stocks in the first half of 2024.

  2. Previous Market Conditions:

    1. Fear as the primary driver of market action.

    2. Fundamentally strong stocks punished due to emotional feedback loops caused by panic.

    3. Geopolitical uncertainty in the Middle East, sticky inflation, and higher interest rates were contributing factors.

  3. Recent Market Performance:

    1. Significant gains in S&P (15%), NASDAQ (17%), and Russell 2000 (20%) since the previous discussion in October.

  4. Current Challenges for Small-Cap Stocks:

    1. Struggles since summer 2021 due to climbing inflation, rising interest rates, and sluggish economic growth.

    2. Geopolitical uncertainty in Europe and the Middle East adding to challenges.

  5. Definition of Small-Cap Stocks:

    1. Referring to stocks in the small to mid-cap range, typically valued between one to twenty billion dollars.

    2. Sensitivity to economic shifts and cycles, reliance on debt for operation and growth

  6. Factors Indicating Favorable Shift:

    1. Climbing inflation, but recent indications of temporary control.

    2. Federal Reserve showing signs of being open to rate cuts.

    3. GDP growth at 4.9% in the third quarter of 2023.

    4. NFIB small business economic survey indicating positive views of the future economy.

  7. Criteria for Long Ideas in Small-Cap Space:

    1. Emphasis on revenue growth.

    2. Looking for outliers that outperformed peers on a fundamental basis.

    3. Focus on exciting sectors with room for expansion and growth.

    4. Consideration of liquidity and implied volatility.

  8. Conclusion and Strategy:

    1. Seeking long opportunities in high-octane small-cap stocks for the first half of 2024.

    2. Stock picker's market; not all small-cap stocks will perform well.

    3. Selectivity is key due to the presence of low-quality stocks in the market.

    4. Advises keeping an eye on small caps, being selective, and paying attention to price action.

Ben Berggreen - Episode 26 - ITPM Flash

Good afternoon everyone! My name is Ben, a former hedge fund manager and institutional trader, as well as a senior mentor at itpm. I hope you all had a great New Year! Today, I want to discuss the potential outlook for small-cap stocks in the first half of 2024.

In my previous video back in October, I talked about how fear had become the primary driver of market action. This led to fundamentally strong stocks being punished due to emotional feedback loops caused by panic. The geopolitical uncertainty in the Middle East at the time, combined with sticky inflation and higher interest rates, contributed to this fear. However, since then, we have seen significant gains in the S&P (15%), NASDAQ (17%), and the small-cap Russell 2000 (20%), with individual stocks performing even better.

Now, the question is, what can we expect in the first half of 2024? small-cap stocks have struggled since the summer of 2021 due to climbing inflation, rising interest rates, and sluggish economic growth. Additionally, geopolitical uncertainty in Europe and the Middle East has added to the challenges. However, I believe this is about to change, setting the stage for a potential revival of small-cap stocks.

When I talk about small-cap stocks, I'm referring to those in the small to mid-cap range, typically valued between one to twenty billion dollars. These stocks often have enough options liquidity for efficient execution, although liquidity can sometimes be an issue. They are also sensitive to economic shifts and cycles because they rely heavily on debt to operate and grow. Many of these stocks need debt to survive, even if they have positive revenue but negative earnings. However, when conditions start to shift in their favor, they can offer significant potential.

So, what has changed recently to suggest a shift in favor of small-cap stocks? The main factor has been climbing inflation, which has been the root cause of many problems. However, the Consumer Price Index (CPI) peaked in September, and both October and November showed consecutive pullbacks for the first time in 12 months. Another measure of inflation, the Personal Consumption Expenditure (PCE) index, also declined in November for the first time since February 2022. This indicates that inflation is at least temporarily under control.

The Federal Reserve (Fed) has been slow to react to the inflation issue, but they are now showing signs of being open to rate cuts. The recent Fed minutes suggest continued uncertainty, so rate cuts are not a done deal. The labor market remains a concern, as it is still tight, which could lead to renewed inflationary pressures. However, the shift towards a more dovish stance by the Fed, combined with cooling inflation, are the first ingredients needed for a potential rally in small-cap stocks.

In terms of economic growth, the US GDP grew by 4.9% in the third quarter of 2023, the strongest since Q4 of 2021. This puts the recession narrative to bed, although GDP growth is a lagging indicator. The National Federation of Independent Business (NFIB) small business economic survey also provides insights into the economic landscape. The survey shows that while there is a labor shortage, particularly in construction, manufacturing, and transportation sectors, there is a positive view of the future economy. Additionally, capital outlays have increased, and owners are more optimistic about longer-term investment spending.

When looking for potential long ideas in the small-cap space, revenue growth is crucial. We want to see strong sales growth, preferably increasing over time. We are looking for outliers that have outperformed their peers on a fundamental basis, considering both year-over-year performance and forward-looking estimates. It's also important to focus on exciting sectors with room for expansion and growth. Liquidity and implied volatility are also factors to consider.

Timing is crucial when trading options, and price action plays a significant role. The iShares Russell 2000 ETF (IWM) has been in a trading range since Q1 of 2022 but has recently broken through major pivot highs. It is currently near Q1 2022 levels after a decent rally. However, there has been a pullback in the market overall during the first week of the year, which could be attributed to tax-advantaged profit-taking by institutional investors.

In conclusion, I am looking for long opportunities in high-octane small-cap stocks that have significant upside potential for the first half of 2024. However, it's important to note that this is still a stock picker's market, and not all small-cap stocks will perform well. Selectivity is key, as there is still a lot of low-quality stocks in the market. So, keep an eye on small caps, be selective, and pay attention to price action.

That's it for this episode. Thank you for watching, and I'll catch you next time!


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