2024 Vision: ASX Small Caps
Happy New Year! We kick off 2024 showcasing the talents of SEVEN of Australia’s top Small Cap fund managers.
2023 ended with big buying in the bond markets sending interest rates south. These fund managers all tip that in 2024 this will translate to buying of select Small Cap stocks. Why? Because that’s where the value is. So get in, because stock is literally limited.
Timing in markets is everything, but it is only a matter of time before the outstanding value we’re seeing in Small Caps gets translated into big returns. Mark not just my words, but the words of all seven investment specialists in this round table, it is all about stock picking.
2023 was a year that included glimmers of the big returns that are on offer. Takeovers have been a theme and this will continue. We kick off the year with another one from Under the Radar Report’s stable, which is straight from our best buys list (drum roll please)… Probiotec (PBP) received a bid from an Indonesian pharma company Pyridam at $3 a share. We first tipped this stock seven months ago (Issue 548, 11 May 2023).
Other big returners from Under the Radar Report’s stable include Gentrack (GTK), Tuas (TUA), Acrow Formwork (ACF) and Southern Cross Electrical (SXE).
Right now you can purchase quality stocks, with proven management teams, bullet proof balance sheets and high returns on the cheap. In this issue, you’ll hear some familiar names, but you’ll also come across ones you’ve never heard of. That’s what being under the radar is about. Don’t worry, over the next 12 months, we’ll sort through them to give you the low-down on the stocks worth putting in your portfolio.
Is 2024 the year for small caps?
Will interest rates be a positive?
TOBIAS YAO, WILSON ASSET MANAGEMENT:
We believe 2024 will be a strong year for small cap companies given the significant under performance versus the broader market since 2021. In fact, many small cap companies are trading at significant discounts to their long run averages. The interest rate backdrop will be positive for small caps as rate hike expectations reduce over the next 12 months and more investors look to the smaller end of town to generate outsized performance.
The interest rate backdrop will be positive for small caps as rate hike expectations reduce over the next 12 months and more investors look to the smaller end of town to generate outsized performance.
ANDY GRACEY, AUSTRALIAN ETHICAL:
Interest rates heading down will be a major catalyst for all equity markets. Smalls and particularly microcaps have underperformed their large cap peers in Australia so it’s not unreasonable to expect a relative catch-up in 2024. Investors however have been burned in the microcap part of the market, so may not immediately return.
CHRIS PRUNTY, QVC CAPITAL:
As a small cap manager I reckon every year is a year for small caps! As Warren Buffett says; you don’t ask the barber whether you need a haircut. There are already some signs of life creeping into smalls. Up until the end of October the Small Ords was down -6% for the year but with strong performances in November and December it looks like the benchmark will finish up in the midsingle digits. And yes; this is almost entirely rates driven with the US 10-year yield falling over 90 basis points to under 4% from the end of October.
BEN RUNDLE, HAYBOROUGH INVESTMENT PARTNERS:
We are bullish small caps for 2024. Small caps have been a poor performing asset class over 2022 & 2023 as interest rates have risen to control inflation. It has been typical in previous bear markets for small caps to bear the brunt of poor performance, which has a lot to do with the lower liquidity levels. The reverse of this happens in an early bull market, however, with small caps tending to rebound strongly. As we enter 2024, our view is that inflation will continue to fall and we are nearing the end of restrictive monetary policy. This environment should see strong performance for small caps.
STEVEN MCCARTHY, DMX ASSET MANAGEMENT:
On the back of a more uncertain economic environment, investors have increasingly adopted a risk-off approach with a preference for large cap liquid stocks. After first entering a bear market in October 2021, small caps over the last two years have attracted a significant liquidity discount, with a large valuation disconnect arising between small and large caps. It is unusual for such a bear market to last more than 24 months, and we expect improved confidence in the prospects for small companies, together with interest rates stabilising, to be the catalyst for interest re-emerging in small caps in 2024. Further M&A activity should also help to close the valuation gap.
It is unusual for a bear market to last more than 24 months, and we expect improved confidence for small companies, with interest rates stabilising, for interest re-emerging in small caps in 2024.
RICHARD BAILEY, KUTTABUL CAPITAL MANAGEMENT:
Small caps have underperformed large caps by 27% over the two years to 30 Nov 2023. That is an enormous gap and one that won’t persist. Whether 2024 is the year it closes through small cap outperformance remains to be seen, but it is a strong position to start from.
I’m not predicting what interest rates will do in 2024, but it seems probable given various global inflation developments that interest rates will provide less of a headwind in 2024.
THE IDLE SPECULATOR, UNDER THE RADAR REPORT:
As a small cap specialist, we think that every year is the year for small caps. But we will admit that the last two years have been challenging in unusual ways, firstly that valuations based on low interest rates evaporated so dramatically, and secondly that the marked underperformance of many small caps versus the bigger companies, which has inserted a liquidity discount in their price.
Yes, interest rates will be a positive, but timing is always an issue. For our kind of stock picking, we just want an environment where interest-rate movements are benign, which appears likely in Australia.
Consumer spending could remain constrained even if interest rates stop going up. In the US, the sheer amount of debt to be refinanced seems underappreciated. We estimate something over $5tn will be issued there, partly to replace existing debt, partly to pay new debt incurred by the $2tn annual US government deficit, and a small amount from quantitative tightening, the ongoing reversal of the federal reserve's quantitative easing process which flooded the system with liquidity.
Interest rates may not rise much, but it will be hard to get superior performance from big caps. The strong performance is likely to come from those stocks that are undervalued, many of which are small caps.