Research.LeutholdGroup

In May 2015, we warned about rich valuations for small cap Biotech stocks and looked at various ways to evaluate those companies, as the majority have no approved drugs on the market, thus no revenue; therefore, valuing these companies using the conventional methodology is problematic.

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“That which does not kill us, makes us stronger” might be a good motto for this never-ending bull market. The bull continues to shrug off the effects of both Quantitative Tightening and an escalating trade war, and it’s doing so during a seasonal stretch in which many of its predecessors have sunk to their knees (if not their demise).

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While momentum has been the best-performing stock selection factor in 2018, there’s a less well-known and purely fundamental factor that rates almost as well: A company’s ability to lose money!

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We don’t have a strong capitalization-bet recommendation, other than to remind readers that Small Caps have been especially responsive to the favorable seasonal window that began November 1st (and which extends through April 30th).

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With this week’s losses, Small Caps have relinquished all of the massive outperformance they enjoyed in the month following the presidential election.

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Our July special report “Active vs. Passive: A Three-Club Headwind” studied the recent dominance of passive indexes over actively managed funds.

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The Ratio of Ratios bounced off last month’s multi-year low (4% Small Cap discount) but still sits firmly below its Small Cap median, which is a premium of 4%.

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The August market action deflated P/E ratios across all market cap tiers, but our ratio of ratios was little changed.

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Nudged higher by Small Cap outperformance in May, our premium is little changed month-over-month and remains in its new 5-10% habitat.

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Small Cap Premium Plunges To 5%

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Small Cap Premium A Tick Higher To 16%

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Small Cap Premium Sinks To 15%

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Small Cap Premium Spikes Back To 20%

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In September, the Russell 2000 index lost 6% and is down 4.4% YTD. Large Caps widened their YTD performance lead (S&P 500 +8.3%). Small Cap Premium slides to 15%.

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Small Caps are selling at a 19% valuation premium relative to Large Caps.

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Small Cap Premium Slumps To 17%

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Emerging Market investors are extending their “small” bet down to Small Caps and the Frontier Markets. We discuss potential reasons behind their outperformance.

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The fifth anniversary of the bull market was met with fanfare, but the launch of the Large Cap leadership cycle in April 2011 is receiving no attention whatsoever.

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Following a great year for trend-following, capitalizing on key reversals in sector performance will be important in winning the 2014 performance derby.

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Small Caps have an historically high P/E premium of 15% vs. Large Caps. This premium could go higher, but we’d be reckless to call for a long-term extension of Small Cap leadership given this premium.

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If we look only at the past eleven years, 2000-2010, the S&P 500 has decisively underperformed the Russell 2000.

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Climbing the bull market stairs. Our initial upside price target for the S&P 500 is 1300 to 1350. This is based on normalized P/E ratios moving to prior bull market average peak levels, as well as on past market peaks.

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Conventional wisdom and modern day historical evidence indicate that Value stocks do better in bear markets. But from the 1920s through the 1970s, it was Growth that held up best during bear market declines.

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NIPA earnings (National Income and Product Accounts) were revised downward significantly. Also believe that Small Cap earnings estimates are overly optimistic.

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Beginning this month, we’ll be distributing a new research publication: Leuthold’s Small Cap Groups. The core of this new publication will be a 15 factor, small cap group selection model based on our time tested, and highly successful, Group Selection (GS) methodology (with a few twists).

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Market seems to be moving toward a possible leadership transition from small/mid caps to large caps. Small caps significantly lagged large caps in July, and also now lag YTD.

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Small Cap indices performance divergence. Why has the S&P 600 significantly outperformed the Russell 2000 the past two years?

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Is “Value” back? Not certain yet, but our thematic Small Cap Value group was upgraded to Attractive this month due to big jump in GS Score.

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Many consultants and their clients have tightened the style boxes and narrowed the definitions to such a degree that it hamstrings the manager….and it’s detrimental to the client’s long term results.

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U. S. focus equity fund inflows are estimated to have risen to $20 billion in November. Also, we highlight a few of the more significant seasonal effects and point out things to look out for in the coming weeks.

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The following table compares the performance of the Russell 2000 Index (since its inception in 1979) with the S&P S00. Over this entire period, the Russell has outperformed the S&P in ten of the twenty years (S0% of the time), producing a slightly lower annual compound rate, 12.4%, versus 13.6% for the S&P 500.

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While we currently believe small cap and secondary stocks will be superior performers in the foreseeable future, we have no idea how long this phase might last. Don't pay any attention to this seven year cycle hogwash.

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In early December, we sent all clients a list of trading stocks to buy in December and sell in January.

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