March 30, 2023

Small-cap stocks have underperformed their larger-cap peers by a wide margin since Jerome Powell’s Congressional Testimony just over three weeks ago.

Part of that is because of the hawkish tone he struck. But mostly it’s because of the fallout of the SVB debacle, concerns over a 2023 financial crisis and what the spillover effects could be on the broader economy.

Consider the following.

Since March 6 the S&P 600 Small Cap Index is down 6.7% while the S&P 500 Large Cap Index is down just fractionally, at 0.8%.

The biggest dents to small caps have come from the financial sector (no surprise there) since smaller banks are where bank runs and worries of a credit crunch have really hit home.

The S&P 600 Small Cap Financial component is down 13.6% since March 6 versus an 11.5% decline in the S&P 500 Financial component.

However, small-cap energy stocks have also been bludgeoned. The S&P 600 Small Cap Energy component is down 13.9% since March 6 (a little worse than the financials) versus a decline of “just” 6.2% for the S&P 500 Financial component.

Financial system instability leads to tighter lending standards (especially among smaller player), which has an outsized impact on rate sensitive areas, such as energy and industrials. This is part of why our newest position, Terex (TEX), took a hit lately.

Despite the pullback in small-cap energy stocks it’s the pain in the small-cap financial arena that’s done the most damage at the index level. That’s because financials make up 17.9% of the S&P 600. Small-cap energy stocks have just a 4.7% weight in the index.

The flip side to this weakness is that, should the 2023 financial crisis turn out to be more sting than bite small caps have a lot of room to make up.

We’ve seen that story begin to shape up this week (albeit just barely). Since last Thursday small caps are up 0.8% (+2.1% in total) more than large caps and are outperforming in all sectors, except utilities and industrials.

While the performance margins are slim thus far and tomorrow’s PCED inflation number will likely determine how the market closes for the week, the bigger-picture story is that small caps are currently down, but not out. That could spell opportunity in both the short-term and the longer-term for those looking to increase allocation to the asset class.

Naturally, we’re more about individual stocks than a broad index. But if you want to play the bigger-picture trend look to the IJR ETF for small-cap index exposure. If you’re feeling very brave the PSCF is the ETF for pure-play small-cap financial exposure.

This little brother to the XLF is where the biggest rebound (or fall) will be should this financial crisis blow over (or blow up).

A final consideration is that turmoil at the small end of the financial sector could drive a wave of acquisitions from larger players and/or small-cap bank consolidation. The chances of that happening are a lot higher now than they were a few months ago, especially after news that First Citizens BancShares will buy SVB’s deposits and loans. Should speculators move into the space (hasn’t happened yet) in we could see the small cap financial ETF take off.

Recent Changes
Huron Consulting (HURN) moves to HOLD

Updates

Enovix (ENVX) has enjoyed a multi-month uptrend as (1) the board approved the design of the Gen2 Autoline (10-times manufacturing throughput versus Gen1) and (2) management announced (ahead of schedule) that its first high-volume production facility (Fab-2) will be built in Penang, Malaysia. The market-pleasing string of announcements continued yesterday as Enovix announced a non-binding agreement with a Malaysia-based manufacturing partner, YBS International Berhad, to fund the buildout and ongoing operations of Fab-2. YBS is publicly traded in Malaysia and grew revenue by 26% in 2022. The company has segments that specialize in electronic manufacturing and assembly, high-precision engineering and precision stamping. While the agreement is non-binding at this point it’s still a significant step in the right direction as it (1) brings in an experienced, local manufacturing partner, (2) offloads what sounds like a good deal of capex and building space, and (3) offloads labor. On the other hand, the press release says YBS will take a “significant financial stake” in the first manufacturing line, so it’s not like Enovix is getting all this for nothing. Still, this seems like a significant positive and the market sure liked it (ENVX was +20% yesterday). It will be very interesting to hear financial details. I expect this partnership will help Enovix qualify for subsidies, credits, etc., that can help lower the total cost of capex for Fab-2. HOLD

Expensify (EXFY) is essentially flat over the last week after it seemingly found support around the 7 level weeks ago. Still on hold. It’s a good company, just needs a little more optimism around small business activity for shares to get going. JMP Securities reiterated a buy rating and 15 price target early last week. HOLD

Flywire (FLYW) is challenging the February 2 high of 29.3 amid a broader push among a handful of SMID cap card and fintech players. Nothing specific to the company behind the little rally. Looking for it to break out of the 23.2 to 29.3 consolidation range that’s persisted for the last two months. Looking for 2023 revenue of $353 - $364 million (+34% at the midpoint). BUY

Huron Consulting (HURN) has put together a nice string of days that has the stock sitting just a hair below multi-year highs. With roughly 10% revenue growth and 18% EPS growth expected over each of the next two years the stock “should” do fine. It’s probably helped that mega-consulting group Accenture (can) reported a better-than-expected quarter last week. That said, with the stock near a recent top (and barely above our entry price in December) I’d like confirmation of a breakout before buying more right here. Moving to hold until we get that confirmation. HOLD

Inspire Medical Systems (INSP) fell below support at 238 three weeks ago when the banking crisis hit. It has since come off the low of 224 and is back in a “comfortable” trading range. Yesterday UBS picked up coverage with a 300 price target (stock around 242). HOLD TWO THIRDS

Intapp (INTA) continues to look terrific so we’ll continue to sit back and watch. Credit Suisse increased their price target from 40 to 48. Not sure anybody is listening to Credit Suisse analysts these days! HOLD

Rani Therapeutics (RANI) provided a Q4 update last week and I covered the details in our Weekly Update. There were no major catalysts in the report and focus remains on the clinical timeline. More specifically, Rani expects to start a Phase 2 trial for RT-102 in the second half of 2023. It also expects to start three Phase 1 studies at some point this year, including RT-111 (partnered with Celltrion) a RaniPill Go capsule containing a biosimilar of STELARA (ustekinumab), RT-105 (adalimumab biosimilar) and RT-110 (PTH for hypo-parathyroidism). The company has $98.5 million in cash and cash equivalents, which should get it through mid-2024. We’re looking for evidence that Rani’s platform can deliver treatments consistently without the need for needles. HC Wainwright maintained its 22 price target after the report, while Merrill Lynch shaved theirs from 22 to 20. HOLD

Repligen (RGEN) is moving sideways on no major news. Benchmark just picked up coverage with a 230 price target (stock around 170). SOLD A QUARTER, HOLD THE REST

Sprout Social (SPT) continues to move sideways in its established trading range. We’re holding half of this position because spending on marketing technology, especially social, is accelerating and Sprout is one of the only pure-play stocks offering exposure. HOLD HALF

Terex (TEX) took a hit when the banking crisis unfolded. It’s looking better now, but investor concerns about a credit crunch hurting smaller customers will likely take a little time to ease. As mentioned last week, management sounded upbeat at the J.P. Morgan Industrials Conference, citing no abnormalities in terms of delayed orders or cancellations. We started with a half-sized position just before the SVB debacle. Timing couldn’t have been much worse. We’ll stick with a half position for now and look for signs that investor confidence is returning to the industrial equipment group before buying more. BUY HALF

TransMedics Group (TMDX) is mostly unchanged over the last two weeks. No news to report. HOLD THREE QUARTERS

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