Smallcap Discoveries: Weekly Update: July 17

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Subject: Smallcap Discoveries: Weekly Update: July 17 - 21

July 17 - 21

Market Commentary

Market

It was a week of mixed result for the markets with both DOW and TSX moving higher by 2.1% and 1.4% while Nasdaq was lower by 0.6%. Continued concerns over weak Chinese economic growth battle optimism that North American and European interest rate hike may be coming to an end.

Interesting to note that the DOW index finally broke through to new 52 week highs after battling the 34,600/34,700 levels for the past year.

This break out for the DOW is a strong technical indicator that, for at least the next few weeks, the bulls have control of the equity markets

Financials

The US dollar index gained some strength this week after briefly dropping below the 100 level. DXY closed the week at 101.09. With the DXY dropping so quickly the past 2 weeks it’s not surprising to see a decent bounce off the 100 level.

Treasury yields have bounced this week and all eyes continue to watch yields for direction after reaching 15 year highs just a few weeks ago.

The Canadian dollar seems to be comfortably trading in a new range between $0.75 - $0.76 to the US dollar. Strengthening energy prices and hawkish talk from the Bank of Canada may keep the CAD$ slightly firmer for the next little while.

Commodities

Oil prices continue to maintain a strong tone these past 3 weeks. Oil closed the week at near 2 ½ month highs with WTI oil closing the week at $75.35.

Baker Hughes drill rig data shows that there were 6 fewer rigs active in the US and no change in the number of rigs active in Canada.

Precious metals continue to move in the opposite direction of the US dollar with gold ending the week off its mid week highs and pretty well flat from last week’s closing price.

Stocks

With the DOW now joining Nasdaq in new 52 week high territory the bulls are clearly back in control and the fear/greed meter is back in extreme greed territory.

It continues to be the bigger stocks leading the market. Small stocks, as measured by the Russell 2000 have lagged considerably behind bigger stocks as measured by the Nasdaq index. Over the past year Nasdaq is up 19.59% while the Russell 2000 has a 7.84% return.

Canadian nanocaps, as measured by the TSXV index, has performed even worse. The TSXV is up only 1.38% in the past 12 months. The TSXV is made up of a lot of money losing companies and with the drought in financing's over the past year it’s no wonder that many investors have shied away from so many small stocks. Of course, the index is made up of all kinds of stocks and we’ve clearly witnessed that many profitable, cash generating companies have done extremely well over the past year. So, performance in microcaps seems to be divided between the haves and have-nots.

I’d expect that now that both the DOW and Nasdaq are in new 52 week high territory the stage may be set for a better market for small stocks. Confidence is needed for capital to flow down market and for financings of smaller companies to be back in vogue again. Afterall, those investment bankers gotta eat too you know…

Small stocks continue to trade at deep discounts to their bigger cousins. The discount has actually widened during this past year’s climbing of a wall of worry. Remember how bad everything looked in November/December of last year? With some of the valuations of bigger names back to nosebleed levels again I’m expecting some of the smart money to be moving to where value is a bit easier to see. And while I’m not expecting that money to come all the way down to nanocap land I do expect some dominoes to push other investors down the food chain. One thing to watch for to see if money is coming to play down in our nanocap sandbox is to watch for some of the bigger, less fundamentally sound microcaps to see bullish activity, maybe even some financings of some of these names. Some of the old market darlings that got a bunch of hype last market cycle are likely to get the promotion engine revving again and make some noise.

In any event, I’m still seeing good valuations in the profitable nanocaps I follow. Compared to the big names they still look extremely cheap. I continue to expect we will see more acquisitions down market and companies taken private. It’s still a buyer’s market for these types of companies albeit many are no longer dirt cheap as they were in late 2022.

I’m starting to believe that the big stocks are going to start dragging many smaller stocks higher. I’m hoping we get one more good buying opportunity before we see a possible big move higher is the nanocaps. I’m exercising patience, hoping to find a nice fat pitch that gives us a decent margin of safety.

Other Stuff

Canadian housing starts for June came in much higher than expected. Housing starts exploded higher by 41% over the month ago period and the largest increase in over 10 years. According to the Canadian Mortgage and Housing Corporation (CMHC) the seasonally adjusted annualized rate of housing starts rose to 281,373 units in June from a revised 200,018 units in May. Economist were expecting starts to reach 220,000.

Most Canadian housing related stocks are still lagging their American cousins. Perhaps the best known housing play in Canada, apart from the commodity lumber producers, is Adentra (ADEN.T). Adentra is one of North America's largest distributors of architectural products to fabricators, home centres and professional dealers, servicing the new residential, repair and remodel, and commercial construction end markets. The stock has performed well of late but still dramatically lags the US home builders.

According to Statistics Canada the population of Canada was estimated to have reached 39,566,248 on January 1, 2023. Today the estimate is 40,176,716 or an increase of 610,468 or a pace faster than the roughly 1,050,000 we saw in 2022. Canada is currently adding an estimated 3000+ new people per day. Check out Canada’s population clock here: https://www150.statcan.gc.ca/n1/pub/71-607-x/71-607-x2018005-eng.htm

Canada has the fastest rate of population growth of all the G7 nations and is one of the fastest growing countries in the G20.

With record population growth in Canada and growing pressure to build more homes in Canada you’d expect more attention to flow to the Canadian housing/building related names. I continue to believe, that for longer term positioning, Canadian housing related stocks are one of the strongest investing themes for the next 2-10 years.

This Week I’m Reading: The Little Book that Still Beats the Market – Joel Greenblatt - In 2005, Joel Greenblatt published a book that is already considered one of the classics of finance literature. In The Little Book that Beats the Market―Greenblatt explained how investors can outperform the popular market averages by simply and systematically applying a formula that seeks out good businesses when they are available at bargain prices. The Little Book that Still Beats the Market updates and expands upon the research findings from the original book.

This Week’s Buys and Sells

No new buys or sells this week.

To your wealth,

Paul and Trevor

Buys and Sells This Week