The Smaller, the Better

It's small caps' time to shine... How we got here... What nearly 75 years of history suggests... Our 'official response' to the Fed's rate cut... The market is starting to wake up... Finding tiny businesses with big upside potential...

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Finally, small caps...

Investors in relatively little-known, smaller but high-quality companies with great growth potential: rejoice. After a few long years, it finally appears to be your time...

I (Corey McLaughlin) am referring to small-cap stocks, which many market folks consider businesses with a market cap below $2 billion. That's opposed to more familiar $10 billion-plus large-cap names or the multitrillion mega-caps like Microsoft (MSFT), Amazon (AMZN), or Nvidia (NVDA).

For the past few weeks, we've discussed the market behavior we've seen in anticipation of and now amid the realization of the Federal Reserve's new "juice." The Fed has already made one 50-basis-point interest-rate cut with the promise of more cuts to come by the end of the year.

This policy shift – after rates had plateaued for more than a year amid the Fed's inflation "fight" – is a tailwind for U.S. stocks in general as monetary policy becomes "easier." The cost of borrowing has and is likely to continue coming down.

In everyday life, you'll start to notice lower interest rates on mortgages, credit cards, and other loans. This could help boost consumer spending in the U.S. economy. (Overseas, central banks in China and Europe are using the same playbook.)

The labor market in the U.S. is showing signs of weakening. But with GDP running at a 3% clip, a lower-interest-rate environment also supports the case for owning inflation hedges, like gold, which has been hitting new highs. Bitcoin has been surging, too.

When we talk about rate cuts, we mean the Fed lowering its federal-funds target range – at which banks lend to each other. The result is a "cheaper cost of money," which may benefit one part of the economy and markets the most... small-cap stocks.

Today, I want to explain part of the reason – and point you to a new free presentation from our colleague and small-cap expert, Stansberry Venture Value editor Bryan Beach, for more detail about how to find some of the very best opportunities in the space.

Setting the stage...

First, the Fed's fastest interest-rate-hike run in modern history, raising rates from near zero in 2022 to above 5% in just 14 months, absolutely crushed small-cap stocks. The Russell 2000 Index, the leading index of U.S. small-cap stocks, fell more than 30% from its late 2021 high.

However, the trend for small caps is back up. While it may not feel like it, given the Russell's volatility, small caps have now been trending higher since October 2023.

That's around when inflation data started to suggest that the Fed might not raise interest rates any higher to fight inflation. Thus, the likely next move would be to lower rates. That took longer than many expected, but this month, it finally happened.

This can be a good thing for all businesses... But many small-cap stocks are particularly sensitive to interest rates, since they're often still borrowing money to grow their businesses more than big, established firms that already see huge cash flows. As Bryan recently wrote to his Venture Value subscribers...

Small-cap stocks tend to need capital to grow and have some debt on their balance sheets. If borrowing is cheaper (meaning the interest rate they pay is lower), they'll get an instant boost to earnings. And there will be more capital available to invest in their businesses.

We discussed this dynamic as early as January, when we said that eventual Fed rate cuts could trigger more speculative investments in sectors such as biotech, which see boom-and-bust cycles tied to financial conditions.

Our Stansberry Innovations Report editors John Engel and Eric Wade made the case for biotech in their January issue. Dan Ferris and I had a great chat with savvy biotech analyst Erez Kalir on the Stansberry Investor Hour in March in which he made a similar case.

More recently, this summer, when more investors in the market became more convinced the Fed was getting close to encouraging lower lending rates in the economy, we saw the "great rotation" story play out with investors getting giddy for small-cap stocks.

The Russell 2000 spiked by 10% in just a few days in July, back close to a new all-time high. Then it round-tripped soon after amid a mini panic linked to a "surprise" weakening of the U.S. labor market.

But small caps are up 9% since an August 7 low. "I think the market is starting to wake up a little bit," Bryan says. "They're starting to creep back up."

And this trend may not be over yet...

I've remarked lately that the benchmark S&P 500 Index and Dow Jones Industrial Average have been hitting new all-time highs, while the Russell 2000 (and Nasdaq Composite Index) have lagged.

The Russell 2000 is still about 9% from matching its all-time high from November 2021, right as the pandemic bull market peaked.

But small caps could get back there soon, if history is any indication. What's more, they could outperform big-name stocks moving ahead. A Fed rate cut could be the catalyst, as Bryan showed...

Going back to 1950, stocks tend to rise when the Fed cuts rates. But small caps rise the most...

On average, small caps have outperformed large caps over the three-, six-, and 12-month periods after a first Fed interest-rate cut over the past 75 or so years. The reason for this performance is straightforward from a fundamental view, as Bryan explains...

First, lower interest rates justify higher valuations on risky assets. Stocks are priced based on their future earnings. Interest rates are the cost of money in the future. So lower rates make a small cap's future earnings more valuable.

And the second reason has to do with the cost of borrowing being cheaper (interest rates being lower), which can boost earnings and free up capital to use elsewhere in the business.

Bryan talks about this in more detail in a sit-down interview with our Director of Research Matt Weinschenk...

An easy way to look at it is just to think about individuals. So, if you've got a multimillionaire and you've got a student who's waiting tables – who's going to feel the impact of an interest-rate rise on their credit cards?

Their credit card goes from 18% to 25%, a millionaire might not even notice. The person who's living paycheck to paycheck waiting the tables, they're going to notice that thing.

The same sort of dynamic is in play with large companies and small companies. Small companies, they generally need capital to grow... [Large] companies have huge war chests. They're not as sensitive to changes in interest rates...

The stock market generally sells small caps when rates rise, and that kind of makes sense... because a small company is going to be more sensitive to changes in their debt structure. Similar – or the exact opposite − when rates fall and that's what we're seeing right now, that is when small caps have tended to outperform.

And this is what we're seeing now.

Of course, if you're buying shares of these companies seeking to maximize your return, you want to find the right businesses that will put the capital to work in the best way possible. If you've read this far, you must be interested...

Finding the best small-cap businesses...

In small-cap land, there are thousands of companies overlooked by the mainstream media and/or institutional investors that won't dabble in such thinly traded stocks... They'll buy the ones that get bigger, but by then, the biggest gains are usually realized already.

This is an advantage for individual investors who do their research and successfully identify the future greats... In our office, we have a few experts...

Recall our friend Dave Lashmet, who recommended Nvidia to his Stansberry Venture Technology readers in 2016... well before the chipmaker became a household name and was more known as a niche graphics-card company for gamers. Now, it's an artificial-intelligence darling. Dave booked a 1,466% return for subscribers in between.

In Venture Technology, Dave and his team identify companies developing medical breakthroughs and other revolutionary technological advances with the idea of generating multiple times your money on an investment.

He takes a "venture capitalist" approach. Regular readers should be familiar with Dave's work.

For example, he has written to you in these pages about breakthroughs in weight-loss drugs long before they hit the mainstream... and the potential impacts of war in the South China Sea on global microchip supply (and related investment opportunities).

'The smaller, the better'...

In Venture Value, which launched in 2017, Bryan seeks out similar growth outcomes, but in a different manner. Rather than needing companies to successfully develop a new medicine, Venture Value is open to a variety of companies with market caps below $1 billion that Wall Street has overlooked. "The smaller, the better," he says, and explains...

We'll also be looking for small companies, but we'll be uncovering some more established companies – many in "boring" businesses – that are flying under the market's radar. Companies that already generate revenues and have an operating history. We also love young or hidden companies in capital-efficient industries like software. And, of course, we'll also pick a few special situations as well – market oddities that could bounce in a year or less based on certain catalysts.

Bryan takes a "bottom up" approach that leads him into a variety of industries. Bryan – a former auditor at a Big Four accounting firm who was one of our Stansberry Research subscribers before joining our team – seeks out small-cap businesses that meet most of his six handpicked financial criteria.

I can't give away all those details. That's the "secret sauce" of his Venture Value newsletter. But I can say, generally, that Bryan is looking for solid small companies that "are capable of scaling up revenues more quickly than their larger counterparts."

And I can tell you right now Bryan thinks it's an "exciting" and "unusual time" for small-cap stocks, for the reasons we talked about today, and more. In fact, just a few days ago, he put together a special report with all the details because, well...

Everywhere I look these days, I see the mainstream financial press touting the potential gains of small-cap stocks.

Why are small caps suddenly garnering so much attention? The reasons are outside the scope of our typical Stansberry Venture Value fare... so we decided to publish a short special report to give you our thoughts.

In this report, Bryan talked some more about the Fed, showed how small caps have been faring against large caps lately, and highlighted his three favorite small-cap stocks right now. Existing subscribers can find this research here...

If you want to learn how you can join them, be sure to watch Bryan's brand-new interview. We're billing it as our "official response" to the Fed's rate cut and plans for more.

Bryan and Matt talk through the opportunity in small caps, discuss how Bryan's newsletter compares to others you might know from our business, and provide some more detail on Bryan's favorite recommendations today and how to put them to work.

Plus, you'll learn how you can get access to Venture Value for 65% off the usual price, and with a 30-day, 100%-satisfaction guarantee and a special bonus presentation from Bryan if you join today. Click here to watch the interview, or read it, to get all the details.

New 52-week highs (as of 9/27/24): American Express (AXP), Booz Allen Hamilton (BAH), Brookfield Renewable Corp. (BEPC), Alpha Architect 1-3 Month Box Fund (BOXX), BWX Technologies (BWXT), Carlisle (CSL), iShares MSCI South Africa Fund (EZA), Fidelity National Financial (FNF), iShares iBonds December 2025 Term Treasury Fund (IBTF), iShares Convertible Bond Fund (ICVT), Lockheed Martin (LMT), Lynas Rare Earths (LYSDY), McDonald's (MCD), VanEck Morningstar Wide Moat Fund (MOAT), NVR (NVR), RenaissanceRe (RNR), Toast (TOST), Utilities Select Sector SPDR Fund (XLU), and ProShares Ultra FTSE China 50 (XPP).

In today's mailbag, a response to a suggestion about what to do with U.S. currency in Friday's mail... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Should we go back to a gold-backed economy? I propose that those that own the gold will own the economy. Look at our history here in the U.S. We used to be a bi-metal country of gold and silver money.

"The rich bankers pressured Congress to go to a gold-backed economy, because no one owned gold but the bankers. Because businesses could not get funding, they failed by the droves, and the bankers bought up their assets at pennies on the dollar. Eventually Congress passed a silver law and silver flowed into the economy thus stimulating it, much as our modern government stimulates it by printing fake money (dollars).

"Read of the Coinage Act of 1873, commonly called The Crime of 1873 to see what transpired." – Subscriber Mark M.

All the best,

Corey McLaughlin
Bay Shore, New York
September 30, 2024