Smallcap Discoveries: Weekly Update: September 26

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Subject: Smallcap Discoveries: Weekly Update: September 26 - 30

September 26 - 30

Market Commentary

You break it you buy it…

Markets took another tumble this past week as investors are coming to believe the Fed will continue to tighten rates as inflation stubbornly refuses to drop fast enough. The Dow reached a new 52 week low while Nasdaq was lower by 2.7% and has still managed to stay above the lows it reached in June. The TSX was lower by only 0.2% and like Nasdaq, it is barely above its 52-week low.

The Fed will tighten until they get inflation under control, which is expected to mean a move decisively towards 2%, or they will “pivot” when something in the financial markets breaks.

Did something just break?

The UK Pound was rocked last week which sent UK bond investors running. The Bank of England had to intervene by buying back long dated government bonds in an attempt to stabilize bond prices amidst concerns over instability of UK pension funds. The UK Pound reached its lowest level ever against the US dollar. The US dollar is turning into a currency wrecking ball, and the pound may not be the only thing getting “pounded”.

This weekend rumours are spreading rapidly that banking giant Credit Suisse may be in trouble. Credit default swaps, which are basically insurance against debt default, on Credit Suisse debt have skyrocketed in price as entities rush to cover their debt exposure with the bank.

And if one big bank gets into trouble it usually means those exposed to that bank could also find themselves in trouble. It’s what set off the 2008 financial crisis only that time it was centered around mortgage-backed securities.

Volatility in currencies and bond markets are like a big finger tipping over a domino, and when one domino tips it tends to set others in motion.

Things in the financial world may be starting to break. What will the Fed do? Mr. Fed Chairman… You break it, you buy it!

Currencies

The US dollar is driving the volatility bus. It’s been on a tear of late and it’s causing all sorts of concern.

The US dollar index hit a high of 114.78 this past week. While it’s been higher in the past it’s the speed at which it’s been moving higher that is causing the problems. The US dollar index is up 23% within the last 12 months versus a basket of the leading world currencies. Within that basket it’s up even more against some individual currencies. We don’t have to look very far to see what it’s doing against the Canadian dollar.

The Canadian dollar has lost 5.3% against the US dollar in just the past 30 days. While the Canadian dollar has been one of the better performers against the US dollar it’s still down about 11% from it’s high almost a year ago. A weaker dollar can cause a whole bunch of problems, but it also can be a benefit to some as a weaker dollar can make Canadian exports much more competitive.

A higher US dollar is likely to cause US based exporting companies to lose competitiveness and we can expect this to impact earnings for a number of large US listed companies. Currency alone could have a 10-20% negative impact on S&P company earnings in the coming quarters. Many companies are already starting to lower guidance because of these currency concerns.

But there in lies the silver lining. Canadian companies that sell into the US market now have an extra edge. Most of their costs are in cheaper Canadian dollars while their income is in higher valued US dollars. It’s something to be aware of going forward. More on this a little later.

Energy

The energy markets appear to be taking a back seat lately to other financial concerns. With WTI oil having dropped by 39% from it’s recent highs it no longer appears to be strangling economies as investors feared several months ago. In Europe however, it’s natural gas that continues to be the issue. Something that is unlikely to be fixed this season no matter what natural gas prices do in Europe. While many politicians in Europe point the blame at Putin the electricity crisis there has been brewing for several years. With the gas pipelines from Russia being turned off it’s made a bad situation worse and it’s unlikely to get fixed anytime soon.

WTI oil closed the week at $79.74 up very slightly from last week. Nymex natural gas closed the week at $6.82.

Gasoline futures spent another week below $2.50 per gallon

Anyone living on the west coast of Canada can only look at those prices and weep. Yesterday we saw record high gas prices at the pump in Vancouver as regular gas was being sold for $2.41 per LITER!

Not much change in drilling activity this week, Baker Hughes drill data showed a net loss of one rig in North America.

Energy stocks have been trading in parallel with the rest of the equity markets having trended lower and seem quite correlated to the “risk on” trade.

Commodities

Gold hit another new low for the year but bounced before the wend of the week closing at $1668.30.

Gold doesn’t look anywhere near as depressing when you look at it in British pounds.

Lumber hit new 26-month lows and is trading at prices last seen at the early stages of the Covid pandemic.

Most of the industrial metals like copper and steel continue to trade closer to their 52 week lows as slowing global demand and the strong US dollar impact prices.

As I have been saying for quite a while now, when it comes to most commodities, it continues to be all about the US dollar.

Stocks

While the big markets are either breaking to new 52-week lows or barely hanging above those lows I’m feeling like I’m watching 2 different equity markets. The big stocks and the very little stocks. The big indexes move based on the fortunes of several very large companies. Passive investments such as ETF’s and index funds have, for years, piled into some of the biggest names such as Amazon, Google and Tesla and their valuations have gone to historic highs. The more money that came into these passive investment vehicles the more that went into the biggest names. Of late, the liquidity that these large companies provided and the derivatives such as call and put options that were available drove even more attention and capital into these names.

Many of these big stocks managed to stay elevated for quite some time while the smaller less liquid company shares began being liquidated many months ago. Nasdaq reached its all time high in November 2021 and arguably entered a bear market (down 20%) in May 2022 or about 5 months. The Dow reached its high in January 2022 and entered a bear market just this past week.

The Microcap market, when I measure it using the LD Micro microcap index, entered a bear market at the start of December 2021 or roughly 10 months ago. Hasn’t it felt like we’ve been in a bear market far longer than the 5 months that Nasdaq has been?

While we need to remember that the stock market is a market of stocks. Individual stocks can buck the overall market trend but in general we have seen 2 very distinct differences between the big stocks and the very small. The big guys continue to be liquid, and the small guys are not. The reason is that institutional capital has moved and continues to move up market, where the liquidity is. The small stocks have been left to the smaller retail and the odd special situation investors and smaller funds and maybe family office money.

Some view this as a reason to avoid the shallow end of the pool. Lack of liquidity should not frighten you away. View it as fewer competitors. What should scare us is crappy companies and high valuations no matter what size the company or amount of trading volume there might be. Don’t worry about liquidity, worry about being right.

Here is a very illiquid stock.

Inventronics made our “Cheapies with a Chance” list on February 24, 2020, when the stock was trading at $0.21. It made our list every year since then including our latest on August 30, 2022, when it closed at $2.40.

It’s hard to see the exact numbers but its highest volume day was in late 2020. It traded roughly 160,000 shares around $0.30. That’s roughly $48,000 in volume. Had you been brave enough to be the buyer that day, where you paid about 50% more than the stock traded the previous day, and if you held that “illiquid” company’s shares until today, you would have turned that $48,000 into $606,400. You would be up roughly 1160% in 2 years. Oh, and you would have received $32,000 in dividends along the way and will receive another $0.35 per share ($56,000) in dividends in a few weeks. On Friday the stock traded only 15,300 shares but that was still more dollar volume then it traded back in late 2020 when it traded 160,000 shares. Don’t worry about liquidity, worry about being right. Liquidity will come. It always does when companies grow their revenues and profits.

A lack of liquidity and a bear market in big, overpriced stocks should not scare us. It should encourage us to look harder. We don’t want to be buying what everyone else is buying. We want to own what everyone else is buying. To make big returns we have to buy before everyone else is buying. That means when others won’t buy whether because of a lack of liquidity or because they are buying upmarket chasing familiar names that they hear about on CNBC or BNN.

Inventronics is still too small for most investors, especially institutional investors. It’s still too illiquid but that changes with a higher price. I’m very happy to own this illiquid little company.

There are other similar opportunities that deserve our attention. Some have begun to move. Having seen this move on IVX.V I’m going through our recent list of 20 cheap stocks to see where the next one might be.

Other Stuff

We interviewed Alchemy Nanotech CEO, Khanjan Desai this past Thursday. Trevor should have the link to the recording available soon. The company continues to grow revenues and reached a new record high in their latest month. The company now has over 525 worldwide installers and Alchemy has just launched new versions of their windshield protection film, are seeing very positive feedback and strong and growing demand for this product. Installation time has been cut down for 2 hours to 20 minutes and management expects this new product to be the most profitable product an installation shop sells surpassing paint protection films.

The company’s stealth clothing contract with the Canadian military continues to progress on schedule. To date the infra red cloaking technology has passed all testing and they will be field trialing this product next month. A successful trial is expecting to result in another contract in the range of $7 - $10 million. There is also strong interest from several other NATO countries including the US.

The company IPO is expected in 2023. Timing will depend on market conditions.

There is still a small amount of the Alchemy financing available. If anyone is interested, please drop me or Trevor a note.

We also interviewed Immunoprecise Antibody CEO, Dr. Jennifer Bath this past week. Trevor should have the recorded version available soon for those that weren’t able to join us. We had a large audience as usual. While we had a number of updates, what I found the most exciting was what I learned about Biostrand and some of the applications they see delivering to clients including some neat stuff around drug patents and protecting patent portfolios. The opportunity seems bigger than I originally thought, and I highly recommend, for those following the company, to listen to the interview and free for all that we had following the call. A warning though, this was one of our longest interviews we’ve had lasting roughly 2 hours, but I think well worth the time.

For those that did manage to catch the free for all, I mentioned how big the prize could be for a company that can help deliver a new drug or protect a drug patent. Just this past week Biogen (BIIB) announced good trial results from their Alzheimer monoclonal antibody Aduhelm (Aducanumab). The stock jumped by 40% or roughly US$11.3 billion on the news.

Merck’s Keytruda cancer monoclonal antibody drug generated US$5.3 billion in revenue last quarter making it one of the best-selling drugs in history. Pembrolizumab, sold under the brand name Keytruda is a humanized antibody used in cancer immunotherapy that treats melanoma, lung cancer, head and neck cancer, Hodgkin lymphoma, stomach cancer, cervical cancer, and certain types of breast cancer. Merck is set to lose patent exclusivity for Keytruda in 2028. What would it be worth to a company like Merck if they were to effectively protect their patent to Keytruda past 2028?

And just one more thing on IPA and Biostrand…

Illumina recently announced a new line of DNA sequencers that will drop the cost of a fully sequenced human genome to $200. Talk about deflation, it cost roughly $100 million in the year 2000 to sequence a single genome. With the cost for sequencing dropping so quickly we are rapidly moving to the era of personalized medicine and the collection of massive amounts of data. How and how much of that data can be effectively used will depend on new technologies that will allow us to efficiently search through and parse the critical information. Much like companies such as Google did for the internet.

More Other Stuff

I was invited to pitch a favorite stock for the Microcap Club Leadership Summit. I chose Ceapro, CZO.V. You can view my pitch below:

I’m also working with a software developer and trying to build some tools that I think would help investors like us navigate the stock selection and due diligence process a little better. I’m finding most investing tools and websites don’t work very well for Canadian listed companies. Anyway, we’ve started with an insider transaction monitoring product that will notify you via email when a company you’ve selected has an insider transaction. We will add other functionality over time including stock screening tools. We are looking for beta testers who are willing to try it and give us feedback. If you are interested you can sign up and try it here: https://insidereye.com/

Ignore the 14-day trial note. It will be free for the foreseeable future.

Canslim Contender

Harmonic Inc.– (HLIT-Nasdaq)

Closing Price: $13.07

Harmonic Inc is the worldwide leader in virtualized broadband and video delivery solutions, enables media companies and service providers to deliver ultra-high-quality video streaming and broadcast services to consumers globally. The company revolutionized broadband networking via the industry's first virtualized broadband solution, enabling cable operators to more flexibly deploy gigabit internet service to consumers' homes and mobile devices. Whether simplifying OTT video delivery via innovative cloud and software platforms, or powering the delivery of gigabit internet cable services, Harmonic is changing the way media companies and service providers monetize live and on-demand content on every screen.