Smallcap Discoveries: Weekly Update: June 5

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Subject: Smallcap Discoveries: Weekly Update: June 5 - 9

June 5 - 9

Market Commentary

Markets

Equity markets were tightly range bound this past week as investors await central bank direction on interest rates. The Dow was slightly higher by 0.3% while Nasdaq eked out a 0.1% gain and the TSX was lower by 0.7%. The move in the Nasdaq index on Friday was enough to break out to a new 52 week high.

The Fed is to decide this coming week if the latest economic data is enough to push the Fed to change interest rates.

Financials

The US dollar index was down very slightly this past week, pausing as investors wait for the Fed decision on interest rates.

The Australian and Canadian central banks, however, took some investors by surprise with both raising their bank rates by 25 basis points. This took the Canadian dollar higher against the US greenback.

Treasury yields have remained stubbornly higher relative to the past few years as economic data stays strong enough to keep investors concerned that the Fed’s fight with inflation isn’t ending any time soon. The market continues to want enough, but not too much, bad economic news to keep the Fed from raising rates.

Canadian bond yields continue to stay close to near 15 year highs putting pressure on banks. A number of Canadian banks raised mortgage rates this past week to keep pace with their cost of capital.

Commodities

Gold had another lack luster week likely waiting for direction from the US dollar and the Fed.

Saudi Arabia announced that they would cut oil production by another 1 million barrels starting July 1. This did little to firm up oil prices as oil actually ended the week lower. WTI oil closed the week at $70.46 down over 4%. Investors remain concerned over a slowing global economy and possible drop in demand for fossil fuels.

As for natural gas, which we haven’t talked about in some time, it continues to trade near 3 year lows in North American markets.

Baker Hughes drill rig data for North America showed a decrease of 1 rig active in the US last week and an increase of 39 rigs in Canada as the lifting of weather related transportation bans are lifted.

Stocks

Remember the calls for an impending recession? The coming stock market crash due to skyrocketing inflation and interest rates? Once again it seems the recession has been postponed. Lots of analysts and economists got it wrong. Some might argue they were just too early.

“The only function of economic forecasting is to make astrology look respectable.” John Kenneth Galbraith

Nasdaq popped into new 52 week high territory this past week. It has gained 22.8% in the past 12 months. The DOW is up 11.4 in the past 12 months and is withing spitting distance of its all time highs. What is happening?

Markets are looking forward. Right or wrong, equity investors are expecting better times.

Interest rates have climbed at some of the fastest rate in history and are at near 13 year highs. Several regional banks in the US went bust. Home prices saw one of the fastest drops in history and are now climbing again. It’s nothing like what they teach you in Economics 101.

Being too bullish or too bearish based on overall market sentiment doesn't do you much good. I’d argue that spending too much time focused on macro sentiment is mostly a waste of time. There’s always a bull market somewhere if you care enough to look. If you are too afraid to look you won’t find those bull markets.

At any point in the market cycle, you can find expensive stocks and cheap stocks. Being too bullish won’t help you and being too bearish won’t either. Being opportunistic when others are too emotional is what sets the best investors in the business apart.

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” — Peter Lynch

There have been some spectacular winners in the past year. Including some in very despised sectors like housing/construction and basic industries.

We’ve even seen some of our microcaps race higher. Even in the hated cannabis space.

Standing on the sidelines due to fears of a down market or recession is rarely a successful strategy.

Other Stuff

I wanted to write about something that Trevor and I spend a fair bit of time researching, when we find interesting companies, but something we haven’t mentioned much in the past. It’s the concept of “Market Sponsor”.

By market sponsor, we mean someone, or some entity, involved in a company or stock that is taking care of the capital market side of a publicly listed company. It’s one thing to run a successful business, it’s another thing to run a successful public company and its stock.

A market sponsor can mean the difference between a company toiling in obscurity and a company that everyone is excited about. It can mean the difference between a company’s stock performing well or a stock skyrocketing.

A market sponsor can be everything from an institutional investor, an analyst, a fund manager, a newsletter writer, a broker, a key investor, or even a celebrity to name a few.

A market sponsor has a vested interest in seeing that a company and/or its shares have and execute a strong and successful capital markets strategy. One that helps the company and inevitably helps the share price.

You can argue that every successful publicly listed company has market sponsorship. By the time a company becomes a large cap it may have gone through and/or continue to have a number of market sponsors that have a vested interest in seeing the company’s share price increase.

I’d argue that market sponsorship is even more important in smaller companies, especially microcaps and nanocaps. The right market sponsor in a microcap can have explosive results, and I mean that in a good way.

A good market sponsor in the microcap sector can mean the difference between a bad financing and a good financing. It can make the difference between a well priced takeover and a poorly priced takeover. A small company, without a strong market sponsor, and this is important, that has a significant vested interest in the company, can fall prey to all the sharks that swim in the microcap markets. Trev and I have stopped counting the number of companies that we’ve seen that have succumbed to unscrupulous investment banking groups and investor relations deals. Someone at those companies clearly did not know what they were getting themselves in to.

We look for sponsors that have experience in the capital markets. They’ve successfully guided other companies through the financing, compliance, and investor awareness landscape. Ideally, sponsors that have a good reputation, strong ethics, strong connections, and strong communication skills.

It’s important that the sponsor either has the skill or knows how to find the person that does, so the company’s story can be told effectively and efficiently. It’s one thing to spend some money on investor relations, it’s another to spend the whole bank balance on it.

Imagine someone like Warren Buffett, Joel Greenblatt or Carl Icahn buying into a small microcap. Would that likely improve the outlook for the stock? I’d feel better about someone like Warren Buffett owning my stock than my cab driver.

And what if Warren was director of the company, would that have more significance? I would say so. Having the market sponsor have a financial and reputational and fiduciary vested interest is even more telling.

Many times, it’s a company’s sponsor that shows up on CNBC, CNN, BNN to tell the company story. They may have connections to analysts, newsletter and blog writers, or social media influencers to help get the story out. Sometimes they are all the above. Having this kind of influence can have dramatic impact.

Finding companies with strong and improving financials is the cornerstone of our investing strategy. We look for companies that demonstrate solid fundamentals and cheap valuations. Those are things that will contribute greatly to the potential for higher share price but having the extra fire power of a strong market sponsor can make an even greater contribution.

Not all small companies have strong market sponsorship but if they continue to improve their business, they may attract the right market sponsor. When you can match strong fundamentals, a cheap price and a company that has, or may have, a strong market sponsor it can make the difference between a nicely rising share price and a rocket ship.

This week I’m reading:

Buy Then Build – How Acquisition Entrepreneurs Outsmart the Startup Game – William Deibel

To your Wealth,

Paul and Trevor

Buys and Sells This Week