Roberts on investing in small caps
Doug Roberts is the managing principal for the Channel Capital Research Institute and author of the new book “Follow the Fed to Investment Success.” Prior to Channel Capital, Roberts served as a vice president and portfolio manager at Bernstein Investment Management and Research. Previously, Roberts was also managing director of the Roberts Mitani Group, a founding member of the board of directors of Benson Eyecare Corp. and served as COO of the Flori Roberts/Dermablend Group.
Roberts spoke with SmallCapInvestor.com’s Jennifer Schonberger on Monday about his investing strategy, the Fed’s current policy and how it relates overall to investing in small caps, and his favorite small-cap picks.
Essentially, “Follow the Fed” is based on the thesis that money and credit policy is the driving factor in the performances of stock prices and earnings. [Those], who do not have capital, cannot grow. The Federal Reserve is the largest determining factor behind this equation. When monetary policy is loose, it benefits small caps because it’s very difficult for them to borrow and gain access to capital, therefore the small-cap “out-performance premium” comes during those periods of time — give or take.
Right now we’re starting to move toward a small-cap environment, which depends on two things: that the Fed continues to maintain interest rates at a low level and whether inflation continues at the current pace. If it continues to do that, then by definition of our formula, the environment for monetary and credit policy is quite loose and once the fear gets sucked out of the market that [will] lead to a small cap rebound].
Currently, there’s no clear indication that the Fed is looking toward raising interest rates anytime soon. By definition then, according to our formula, we’re in a small-cap environment and will remain so in the foreseeable future.
As long as the Fed maintains its loose monetary policy, continues to keep rates low and we don’t have a huge downtick in inflation, I think the answer is that eventually a small-cap rally is going to have to kick in.
[In the past,] there was a massive amount of fear and small caps got killed. But when the Fed began infusing liquidity in the market and the market was reasonably certain that they would continue to do that, small caps had major rallies. We saw that during the 1930s and the 1970s. That’s where most of the small-cap-out-performance premium comes in.
Certainty of access to liquidity is a key ingredient. They have to know that there’s going to be money available for small caps. That’s why there’s a lag effect. People are very scared, but once they know the Fed is behind it and is continuing, you’ll see the lending start. We’re probably not quite there yet, but if the Fed continues, it’s almost a tipping point. In 2003, people thought it was going to be a terrible year, but then all of a sudden it kicked in and it was like going to the races.
AZZ Inc. (NYSE:AZZ) is based in Texas and manufactures electrical equipment and components for power generation and transmission in the United States. It operates in industrial products and galvanizing services. What we’ve found [in the sector] is a good long-term trend of energy costs increasing, which is an enabler. The company is relatively cheap. It has a price-to-sales ratio of 1, a trailing P/E of only 12 (which is less than the market), no debt and good financials.
My second pick is a company called Corvel Corp. (Nasdaq:CRVL). It handles medical cost containment and managed-care services, and manages the medical costs of workers compensation and other health-care benefits under group health and auto insurance policies. Health care will continue to be an issue. They’re looking for more and more ways to deal with that situation and Corvel is positioned well.
If you want to try something a little different, you may want to try A-Power Energy Generation Systems, Ltd. (Nasdaq:APWR). It designs, constructs and tests distributed power generation systems for people in the People’s Republic of China. It’s based in the United States, but most of its operations are in China. [The company is] only trading at a trailing P/E of 9. This is a little bit more speculative, but again you’re talking about something with a build out in power infrastructure, which is again the right place to be.
One of the best ETFs is the one that tracks the S&P 600 (NYSE:IJR) and that’s done quite well. Standard and Poors is doing the stock selection and the upgrading for you. It’s one that’s relatively cheap and good way to play the exposure to the entire industry. I also favor the Russell 2000 Value ETF (NYSE:IWN).
For more information on Roberts’ strategy, visit www.followthefedthebook.com.
