‘Earnings recovery will be more profound in small-cap stocks:’ Portfolio Manager

Yahoo Finance’s Alexis Christoforous and Eric Marshall, Hodges Small Cap Fund Portfolio Manager, discuss the latest run for small-cap stocks.

Video Transcript

ALEXIS CHRISTOFOROUS: Would love for you to stick around for our next guest, because we want to speak with Eric Marshall. He is Portfolio Manager at Hodges Small Cap Fund.

And Eric, good to see you. I want to talk about this phenomenon we saw in small-cap stocks for 2020. They had a great year, looked like they were off to a good start this year. And then we sort of just started to see this rotation out of the small caps. Where do things stand right now?

ERIC MARSHALL: Well, certainly, small caps have had a very nice run in the last couple of months. And I think one reason why they had was because of the earnings recovery that's underway is probably going to be more profound in small-cap stocks. They tend to be more economically sensitive. So as earnings recover in 2021, we think that they'll see a disproportionate benefit in the earnings recovery.

We also think valuations were very attractive for small caps relative to large caps. They traded at much lower multiples. And we started to see some catch up here over the last couple months. Now, we wouldn't argue that this is really a time to pay attention to valuations. And while we may be overbought here in the short run, we would use a pullback in small caps to selectively buy those on fundamentals.

JARED BLIKRE: Well, Eric, I wanted to get your take on the currency market here. We've seen positioning against the dollar, in other words, bets on the dollar going lower, get to extreme levels here. And usually, short-- usually small caps tend to do well, at least better than their international cohorts, when int-- excuse me-- when the dollar is rising. They tend to outperform. But I'm wondering, could it be a little bit different this time? What are any headwinds you see for small caps based on this?

ERIC MARSHALL: Well, generally speaking, a lot of these stocks, we think small caps actually do well in a rising interest rate environment. So I think because they do represent opportunities of growth, they do-- historically have traded at higher P multiples. That really hasn't been the case. And they are more economically sensitive. And as the areas of the economy reopen in 2021, we think that the earnings recovery for a lot of smaller companies will be more profound, and we'll see more multiple expansion in those type of names.

ALEXIS CHRISTOFOROUS: Now, speaking of interest rates, you've got the Federal Reserve meeting this week. What are your expectations for that meeting? And talks have been heating up about inflation becoming more of an issue-- or an issue, it really hasn't been an issue for a long time, later in the year, and that may be needing the Federal Reserve to force its hand to raise interest rates. What are your expectations there?

ERIC MARSHALL: Well, we don't know the exact timing of interest rate increases or what the Fed will or will not do. But what we would say, there's been a lot of liquidity in the system here over the last six to nine months. And eventually, some of that could start to translate into inflationary pressures. We're already starting to see that in the cost of goods in many of the companies that we follow, which will, I think, favor some of the companies that are more industrials, have hard assets, that can pass on those higher inflationary costs, which will inevitably inflate earnings.

JARED BLIKRE: Eric, let me get your take, then, on the regional banks. We just had a slew of earnings from them after the big banks. And they comprise a substantial portion of the Russell 2000 index. What's your outlook for them, especially considering what you may see the Fed doing or not doing in the near future?

ERIC MARSHALL: Well, I think that not all regional banks are created equal. And I think right now investors really want to focus on those that are more asset sensitive, meaning that if interest rates do go up, some banks will benefit a lot more than others because of the floating rate loans and so forth that they have on their balance sheet. So we would look for the banks that are more asset sensitive and still see opportunities in those over the next 12 to 18 months.

ALEXIS CHRISTOFOROUS: Eric, this afternoon, President Biden is expected to sign an executive order that would back his Buy America promise, making it more difficult for companies to take advantage of some loopholes to do deals with companies overseas. How might that play out for small and mid-sized companies who might actually see a benefit from this when they go up for things like government contracts, perhaps things will be a little easier for them after this executive order.

ERIC MARSHALL: Well, it's hard to make any specific bet on an executive order as far as building an investment thesis around it. But generally speaking, a recovery in the manufacturing sector here in the US would be good for small-cap stocks. Things like steel producers and, you know, manufacturing industrial distributors, those type of companies really stand to benefit.

ALEXIS CHRISTOFOROUS: You brought along with you a couple of stock picks. I want to get to them before we let you go. One of them is Michaels Companies, the craft supply store, who my daughter always loves to drag me into. Tell me why you like Michaels Companies.

ERIC MARSHALL: Well, this is a retailer that's undergoing a turnaround. They were impacted negatively by a lot of their stores being closed down during the pandemic. Now, they're reopening. We think earnings can get back to $2 a share, and we can see the stock trade back up north of 20, and it's trading around the $15 area today. And so we like the earnings leverage there in the recovery situation and see it as a very attractively valued retailer.

We also like Commercial Metals, which is a rebar manufacturer that should benefit from an eventual recovery in infrastructure spending. They have about 50% of the melt capacity out there for rebar, and we think that there's going to be demand when we do finally get some federal highway funding.

ALEXIS CHRISTOFOROUS: Before we let you go, you also brought along Rambus with you. You like Rambus in the chip space. Why?

ERIC MARSHALL: Well, this is a company that really, they make chips that buffer between data and where that data is processed. So they sit between a memory in the processors. And this is really a way to play in the small-cap space, we think, what's going on in memory.

And Rambus is actually going to come out and report today after the close. And we wouldn't necessarily buy this stock based on any one quarter, but we see a nice secular growth trend in data, in the memory market, and think this is a good way in the small-cap space to play that. And it trades at a relatively reasonable valuation.

ALEXIS CHRISTOFOROUS: All right, Eric Marshall, thanks so much. We appreciate your time.