Smallcap Discoveries: Weekly Update: December 12

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Subject: Smallcap Discoveries: Weekly Update: December 12 - 16

December 12 - 16

Market Commentary

Markets

Markets sold off this week as hawkish comments from Fed chairman Powell and the ECB took priority with investors over the weaker than expected inflation data released early in the week. The Dow finished the week down 1.7%, Nasdaq was lower by 2.7% and the TSX was down 2.5%. After a roughly 20% bounce off the lows in early October the DOW looks to be in a down cycle that will test investor’s fortitude going into the end of the year.

Lots of reasons to be bearish the overall markets in the short term and with the US Fed having raised interest rates to their highest level in 15 years markets and many other assets will continue to adjust to the new, higher rate environment. That said the volatility and change in outlook continues to favor the stock pickers. Lots of companies and sub sectors that will do well in this changing environment.

Energy

I’ve been seeing more bearish sentiment around oil lately, which the contrarian in me thinks is a sign that we are likely near a bottom in WTI oil if we haven’t already bottomed.

The Biden administration has announced that they intend to start refilling the strategic petroleum reserve and has started making purchases with delivery scheduled for February 2023.

I feel considerably more bullish at these levels and believe the SPR “put” will put a floor into the price and likely stabilizes oil here and will help hold the $65-$70 level on the downside. I think oil likely outperforms the oil stocks in the coming months and think the buy oil/sell oil stocks play continues to look good for now.

I’m not long the trade and have no energy producer exposure but continue to play the space through my energy service stocks, predominately Bri-chem (BRY.T) which has been slowly moving higher.

Drilling activity has slowed down a bit over the past 2 weeks as can be expected since we have seen near year lows in the price of oil and weakness in natural gas. There were 7 fewer rigs operating this past week according to the Baker Hughes drilling data report.

Commodities

The US dollar index started the week lower after the lower-than-expected inflation data but then saw some strength on the back of the hawkish Fed speech. However, the DXY still couldn’t close above the technically important 105 level. It’s one of the charts I’m watching the closest as there are many implications and the US dollar is great barometer of global fear. A weaker dollar portends less fear and more global stability, and the recent trend lower has taken some financial strain off many sectors and emerging markets.

Most commodities have seen lower volatility lately as the dollar has lost strength. Gold this past week was slightly lower and managed to close slightly above the $1800 level, closing at $1800.60 per ounce.

Industrial metal investors continue to watch China as it tries to emerge from Covid lockdowns and re-energize its economy. Copper continues to move mostly sideways as does steel and other metals tied to the Chinese real estate markets.

Stocks

General market sentiment seems to have turned bearish again. I expect we will see the major indexes head lower into the end of the year. I’ve been bearish the big stocks and bullish the small stocks for some time and I see nothing to change that stance. A number of the very small stocks we follow have actually had a very decent past few months and some, while still cheap are less cheap than they were a little while ago.

Penthouse to outhouse…. In past weekly updates I’ve mentioned Cathie Wood’s ARK Innovation fund and have used it as an example of investors chasing the past leaders and the belief that growth at any price was a viable long-term strategy. That might have worked in a super low-rate interest rate environment, but it certainly has not worked in a rising rate environment. The very popular ARK fund is down roughly 63% for the year and down 79% from its high reached in early 2021. It is testing 5-year lows. The fund has approximately $7.1 billion in assets and every single one of its 30 holdings is down this year by an average of roughly 60%. It’s stunning to think a professional money manager, and one that has been as acclaimed as Cathie Woods, can perform this poorly and yet still have as much investor capital as she has. It will be interesting to see how long investors maintain faith in her investing strategy if interest rates stay higher for longer…

Markets rotate. No investing strategy works in every market environment and in the long run I believe price does matter. We are in a very different market environment than we witnessed over the past 10-15 years since the great financial crisis. Interest rates are at 15-year highs. Inflation is at 40-year highs. What worked in the last bull market is not likely to work well in the next bull market. New stocks will lead the next bull market, but different investing strategies are likely to work better than what worked in the last bull market. One of my favorite investors, Howard Marks, in his most recent investing memo, highlights the “Sea Change” that he is seeing in the current investment environment. I highly recommend reading his latest memo.

sea change (idiom): a complete transformation, a radical change of direction in attitude, goals . . . (Grammarist)

Mr. Marks says, “In my 53 years in the investment world, I’ve seen a number of economic cycles, pendulum swings, manias and panics, bubbles and crashes, but I remember only two real sea changes. I think we may be in the midst of a third one today.”

I agree with Mr. Marks. We are moving into a significantly different market than what many investors have seen in their lifetime and strategies that worked in the recent past may be the opposite of what is needed to be successful in this new environment. I think it’s prudent to be willing and able to adjust. We need to be prepared to think differently. Low interest rates changed so much of how we view investing. I believe higher rates will be around for longer and this will change many things. The type of stocks that will do well has changed. Valuations, based on traditional fundamentals, will be more important. A company’s ability to generate cash profits, to be self sustaining without the need for cheap debt or equity will be given more value. Maybe even financial common sense will become in style again, lol.

Most investors look at market cycles and what they see is indexes that go up and down, stocks that go up and down. What they are witnessing is rotations. Capital rotates. It rotates from sector to sector, from stock to stock and from investing strategy to investing strategy. Great investors try to find strategies that can still work well in these rotations but even Warren Buffett has periods that he under performs other strategies and other fund managers.

I believe that we are entering an investing environment where today’s cash flow and profits are worth significantly more than future earnings. Many of today’s hard assets are more valuable. Think existing factories and old school businesses, think local supply chains vs global supply chains. Think sunk capital vs future capital.

I’ve mentioned this investing theme before. There looks to be a North American manufacturing renaissance. Is your investing strategy taking advantage of this?

A new investing paradigm may be upon us. Watch for the indications that will validate this. Watch which stocks and sectors are showing relatively better strength, watch the 52-week highs. Adjust your strategies to better reflect this changing environment.

Other Stuff

As we approach the year end it’s good to look back and reflect on what has worked and what hasn’t. 2022 was a year of rotation for me. While the overall market had a rough year many of the smaller, fundamentally sound companies we follow closely, had a decent year. For sure this was somewhat helped by the fact that the last 10 months or so of 2021 were dreadful for many small companies and this past year was a year of rebounding from decade low valuations for nanocaps and microcaps.

Our January 2022 Cheapies with a Chance list stocks to date have returned a decent 36.4%. Not bad considering the rough markets and decades low liquidity we have seen in the smaller stocks.

Companies like Inventronics, Bri-Chem and Fab-Form have been stellar performers.

I still believe there are fantastic opportunities in the nanocaps and microcaps that show growth while maintaining profitability. My strategy continues to be to look for companies showing outsized revenue growth while maintaining solid profits and cash flow. Many valuations of these nanocaps are at decade lows which lowers our risk while providing the potential for significant multiple expansion when investor sentiment turns more positive. I’m doubling down on those that continue to execute and are still showing good value.

I’m going into 2023 with the conviction that we have one of the best buyer’s markets I’ve seen in fundamentally strong nanocaps.

Other, other stuff

We were hopeful that Zedcor (ZDC.V) would give us an opportunity to buy a good-sized stake in the business but unfortunately it looks like it has run away a little on us. We have prepared a report on the company, but we’ll have to adjust the numbers somewhat due to the rapid change in price. I’d mentioned in then past few months that I was buying the stock around the $0.45 level. It has gone almost parabolic, and this past week hit $0.60. The move was enough to make me sell some and take some profits. I’m still a big fan of the company but think we are likely going to see pull back in price, so I was happy to take a quick 33% profit. I’ll be watching for a chance to start adding back.

Inventronics (IVX.V) seems to have found its way again. I was adding what I could in the $2.50 – 2.80 range. This week it closed at $3.35. It continues to be one of my current favorites and while I still think it’s quite cheap. I’ll hold off on adding any new shares for now.

ImmunoPrecise Antibodies (IPA.Q) announced their quarterly results and business highlights this past week. Revenues were up 9.8% over the same period last year. The company generated a loss of $7.35 million as it continues to see an outsized spend on research and development as it moves several preclinical assets towards the clinic and into partnership discussions.

Another little favorite of our, IBEX Technologies, (IBT.V) reported Q1 financials which were a little bit better than we were expecting. Revenues were slightly lower by 1.7% from last year but earnings were better by 2.1%. The company has added $518,354 to its already impressive cash balance of $7,641,052 bringing it to $8,159,406. A considerable sum for a company with a market cap of only $14.1 million. The stock closed on Friday at $0.57, up 14% on the news.

I’m watching Ceapro closely and considering adding to my position this week as the stock is now trading in the low $0.60. I’m also considering iFabric (IFA.T) and Kits Eyecare (KITS.T) as potential tax-loss selling/Santa Claus rally buy opportunities.

Canslim Contender

Unfortunately, due to time constraints we won’t be posting a selection this week.

Happy Holidays

Trevor and I want to wish you and your family the best of the holidays and are very thankful for your ongoing support of our work.

To your wealth,

Paul and Trevor

Buys and Sells This Week