December 15, 2022

Small-cap stocks continue to trade in the same 5% range that they’ve been in for the last month. On the S&P 600 Small Cap Index that translates to a range of 1,184 – 1,252. At the low end of that range we have the upward sloping 50-day line.

I’ve been keeping an eye on the 1,230 to 1,300 range as I think a few weeks of stability in that area would signal greater investor confidence in the asset class, which continues to trade at a steep discount to large caps.

Here’s the chart.

Taking a look at valuation ,we see the small-cap index currently carries a forward P/E of 12.8. It’s been in the 10 to 14 range for most of the year, well below that of the S&P 500 Index, which currently carries a forward P/E of 17.3 and has been in the 15 to 18 range for most of the year.

At this point most big investors are well aware of the small-cap discount. As I’ve been writing for a few months, it’s become something of a consensus view that small caps should outperform in 2023.

But we need the broad market to get in gear for that potential to be realized. And with the Fed continuing to beat the “higher for longer” drum we’re just not seeing momentum build yet.

Prior to yesterday’s rate hike decision the market was trading nicely higher. When the 50bps hike was announced – no surprise there – and the new summary of economic projections (SEP) hit, the market dove into negative territory.

In my view there wasn’t really any new information from the press conference, or the FOMC’s statement and the SEP. The Fed remains data dependent and while recent inflation reports have been encouraging they need to see a much more significant decline before even entertaining a discussion around easing.

As expected, Jerome Powell continued to drive home the point that the current sticking point is inflation in services, excluding housing-related services (goods inflation has come down nicely and the housing market is in recession). This is where the labor market continues to be too tight and the Fed wants to see some signs of normalization, which they think could happen around mid-2023.

There will continue to be a debate around if there are structural shifts in the labor market, demographics, etc., that are affecting the labor market and make a 2% inflation target outdated. But the Fed sees reevaluating that target as a longer-term project they’ll start in the 2024 – 2025 timeframe, not today. So, if you enjoy reading on these topics expect debate, but no action.

Back to the market and small caps, I think the press conference yesterday reduces the chances of a meaningful end-of-year rally. The market will continue to focus on economic data releases until the next FOMC meeting and press conference, on February 1, when a 25bps hike is now expected (72% probability).

For now, the bottom line is that not much has changed. I continue to see stocks that I like and which should do well in a more investor-friendly market. But we’ll continue to proceed with caution since, while overall market conditions have improved versus a couple of months ago, we’re still not seeing enough momentum out there to get incrementally more bullish.

Recent Changes
None

Updates

Enovix (ENVX) has dribbled about 6% lower over the past week. The only news is that the company received ISO 9001:2015 certification for the Fab1 manufacturing facility in California, which means their Quality Management Systems (QMS) and enterprise business processes meet industry-recognized standards. Recall management was at the Advanced Automotive Battery Conference (AABC) last week and while there were no major announcements, reports from analysts suggest high interest in Enovix (among other battery technology companies) and growing conviction in the company’s plan to ramp up manufacturing. That all said, clearly Enovix has a somewhat higher risk profile given it’s just moving from development into revenue stage. BUY

Flywire (FLYW) is up modestly over the last week and is attempting to push through its 200-day line. That effort has failed on the four previous attempts, so the odds aren’t in our favor. That said, a move through the 23 to 24 range could lead to a positive change in character for the stock. Nothing new on a fundamental level to report. BUY

Huron Consulting (HURN) came back to its 50-day line this week. This trendline has offered reliable support for HURN since spring and will hopefully do so again this time. Huron is a small consulting company that helps clients develop sound business models, streamline operations, embrace digital transformation and navigate constant change. Its biggest market segments are Healthcare and Education, which represented 42% and 26% of 2021 revenue, respectively. The remaining 32% of revenue came from what Huron now calls its Commercial segment, which includes energy and utilities, financial services, industrials and manufacturing, and public sector markets. Examples of clients include health systems, academic medical centers, universities, research institutions, banks, asset managers, private equity firms, oil and gas and utilities companies and the federal government. The company has recently begun to focus more on its strength providing digital services, such as helping customers transition to cloud-based tech and analytic solutions. BUY

Inspire Medical Systems (INSP) has had a nice week, including an 8.3% rally on Tuesday. Part of the reason is an upgrade from Goldman Sachs and initiation from KeyBanc. HOLD TWO THIRDS

Procept BioRobotics (PRCT) continues to be rangebound in the 41 to 47 area. There’s been no significant news to share since the company beat Q3 expectations (revenue was up 135%) in early November. This week Wells Fargo bumped up their price target on overweight-rated PRCT to 52 from 49 (stock closed at 42 yesterday). HOLD

Rani Therapeutics (RANI) has been stable in the mid-8 range in the week after reporting positive repeat-dose data for RT-102, the Phase 1 study evaluating RaniPill GO capsule given daily for seven days with human parathyroid hormone (PTH) analog. I reviewed the results last week. The punchline is that the data showed that the repeat doses were delivered with a 91% success rate, were generally well tolerated, and there were no severe adverse events. That said, two of the 17 study participants experienced abdominal pain characterized as “mild and transient”. This may or may not have been related to RaniPill. Rani expects to start a Phase 2 study for RT-102 in the second half of next year. That study could have multiple dosing levels and longer treatment duration. Remember that RaniPill delivers up to 3mg drugs while the RaniPill HC delivers up to 20mg, which expands the number of biologics that could be delivered. HOLD

Repligen (RGEN) rose modestly over the past week but big picture the stock still lacks momentum. Recall from the Q3 report that Repligen is in the middle of a roughly four-quarters-long destocking trend as customers reduce inventory following the COVID-related buildup. There is also some headwind from foreign exchange, though that trend is improving given the dollar has pulled back from highs from September, October and November. Risk from China lockdowns, which could impact up to 10% of revenue, is also fading as the country softens its stance toward COVID. Repligen is still the best out of the bioprocessing pure-play group. While next year’s growth in the base business of 15% to 20% is likely to be offset by the aforementioned headwinds resulting in no growth in 2023 (absent acquisitions) we should see a return to 20% revenue growth in 2024 with significantly greater EPS growth as cost control measures now drive leverage in future quarters. Worth being patient. HOLD

Sprout Social (SPT) has been moving sideways, mostly in the 47 to 70 range, since the spring. While not a bullish trend that’s considerably better than most software stocks and should serve as some comfort that SPT remains a stock that bigger investors want to own. A recent note from Morgan Stanley dove into why exactly the stock deserves a premium valuation. Their answer hinges on the so far successful move upmarket, price increases even into a weaker economy, a deeper relationship with Salesforce.com and opportunity for Sprout to do even more with that company as Salesforce is set to wind down its own Social Studio product in the next couple of years. The potential downside of the deal with Salesforce is that either (or both) the company fails to execute on the opportunity to integrate the platforms and drives customers to Sprout. On the other hand, clearly there is acquisition potential here. With revenue growth expected to top 30% for the next three years and Sprout right on the cusp of break even in 2023, we’ll stay the course. HOLD HALF

TransMedics Group (TMDX) received a price target boost from JP Morgan this week (to 67 from 61). The increase was driven by the company’s continued execution and momentum heading into 2023. Assuming TransMedics delivers as expected in Q4 revenue should be up around 200% this year and track well above 40% in 2023. The stock traded up to its all-time high this week. HOLD THREE QUARTERS

Treace Medical (TMCI) was sold on December 6 for a modest gain of 8%. We held the stock for only about a month, but given the rollercoaster (thanks to a short-seller report) and reality that we haven’t seen a ton of stocks break above overhead resistance (TMCI has been trying, unsuccessfully, to break out since mid-September), I felt the best move was to reduce our exposure. I’m keeping an eye on TMCI for the future. SOLD

Xometry (XMTR) had been holding above 40 until the last couple of days when the stock slipped back toward the November 10 low of 36.1. Keeping a close eye on that level. Despite a rocky Q3 resulting from high demand (orders +55%) but low job acceptance price (net result was lower prices for buyers and lower-than-expected revenue) the potential here is still significant. The Xometry marketplace is seen delivering around 40% revenue growth in 2023, assuming of course that management has properly tweaked the algorithm. This week Citigroup picked up coverage on XMTR with a buy rating and 55 price target (stock closed at 36.5 yesterday). HOLD

Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.