The broader stock market has been in a bear market for the past few months, but most wouldn't know it, as the mega caps have buoyed the entire market until the past 3 weeks. Yes, we know interest rate and inflation fear is bringing down multiples, but this has actually been taking place for many months in small and mid cap names. In fact, the recent index selloff has brought some of these smaller companies well past their 52-week lows -- quite an odd juxtaposition for a market that is still supposedly only 10% off all time highs.
How Can This Happen!?
Currently, the top-10 stocks in the S&P 500 index comprise more than 1/3rd of the entire index. In other words, a 1% gain in the top-10 stocks is the same as a 1% gain in the bottom 90%
NASDAQ Composite (3,605 stocks) was only 3.6% away from its 52-week high as of December 13, but its average stock was down almost 40%
The mega caps are so large and diversified (look at the broad reach of Amazon, Google, Apple), they have become modern-day bonds. When there is fear in the market, as was the case with COVID, these names became safe-havens for cash
“Just 10 stocks are around 30% of the weight of the S&P 500, and 25 stocks are close to half. These stocks did well, and therefore the indexes did very well. The indexes are essentially a specific asset class of very large-cap stocks, and that asset class had a very good year. If we dig deeper, though, the picture is not quite as attractive.” -- James “Rev Shark” Deporre, 2021 Was a Lousy Year for the Stock Market
The Russel 2K, which tracks the performance of US small cap companies, just hit a fresh 52-week low
Some of the most innovative (yes, cash flow negative too) stocks are already down 75+%! Take a look at the charts on names like AI, MGNI, SQ, etc.
Folks, the bubble has already popped in various corners of the market! Brace yourself for more volatility as the indexes capitulate, but be ready to be selective in buying good companies at fair prices -- don't get swept up in the fomo and dip buying that defined this latest bull run
We have been in a stealth bear market for many months now, and we view this as a positive, as it has finally allowed us to really look at starting new positions for the first time since 2020
The vast majority of the broader index gains over the past year have been concentrated in a few big names that have received massive inflows due to their safe haven status, rather than future growth prospects, for the most part...
(Source: Bank of America, Bloomberg)
What it Means to Us
Double Haul Capital really started to take off based on an all-in bet on small-cap oil E&Ps during the overdone COVID selloff of oil... we have been anticipating this rotation back into energy, after years of underinvestment, for a while now, and we are sticking with these picks (LPI, CDEV, CPE, REI). They appear to be fundamentally sound amidst the broader selloff
We currently feel that the market is still undervaluing the cash flow potential of these companies by at least 50-70% at current strip prices... most expect to start returning cash to shareholders early 2023, potentially spurring the final big pop in these stocks with more rotation back into value
There is still the potential for multi-baggers in some small cap OFS plays, as they have not yet benefitted from this rebound in oil prices... FET is currently our favorite name in the space
We have opened a few positions in select small cap names that we feel are grossly undervalued, but we are making sure to leave room to scale into these positions as they are still likely to be punished when the mega caps bring the indices down further
While we do not feel there is a strong need to go all-cash in this environment, we do suggest selling some over-extended multiple stocks so that one can participate in the fire sale on certain growth stocks that have been unjustly punished by the selloffs
One of our favorite sectors overall is in adtech, where we expect the supply side ad inventory players that are already cash flow positive to experience tremendous growth on the back of growth in CTV (connected tv)... check out PUBM, MGNI, PERI, TRMR
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