Four small-cap specialists discuss where they believe the current investment consensus is mistaken.
Q4 hedge fund letters, conference, scoops etc
Chuck Royce: Focusing Too Much On Short-Term Rates
In this decline that started in early September, interest rate conversation took on a high profile. Everyone wanted to debate: Did Powell say the right language about what he might do in the future? Big conversation. Wall Street Journal arguing with Powell, et cetera about just the language should have been different because Powell was too data-driven.
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I think that was a kind of silly conversation. Rates have been returning to normal for some time, certainly in the short-term structure. So I think that goes away and that conversation won’t happen again. So I think that’s one of the negatives that caused this decline or was in the coversation that I think will evaporate. We have led the world up in rates. We are still absolutely the highest, but I think that will take on more of a positive hue than a negative hue.
Francis Gannon: More Earnings Growth Than Expected
One of the key areas that the consensus might be mistaken this year is around earnings and earnings growth within the small-cap space, which argues for selectivity in the small-cap space.
I think you’re going to see strong pockets of earnings growth within certain areas within the small-cap space, especially those that are more economically sensitive or cyclical.
Jay Kaplan: The Potential For Inflation
I think the consensus is missing the potential for inflation. When you talk to companies who manufacture here in America, most of them will tell you that their supply costs—whether it be materials or labor—those costs are under pressure and they’re going up. You don’t see that in the printed inflation numbers yet. I suspect we will. You don’t see wage inflation in the numbers yet. At some point I think you will. I think the consensus is wrong on the potential for inflation. I think the consensus is anticipating a recession pretty soon. The stock market action will tell you that. The flattening of the yield curve will tell you that. From what I can see, a recession really isn’t imminent, and I think the market has that one wrong.
Steve Lipper: China’s Economic Slowing And The Fed
I think the consensus may be wrong in two areas. The first is I’d suggest that during much of 2018 the market underreacted to the consequence of Chinese economic slowing, and then it became obsessed with it and thinks it’s going to continue to get worse and ripple, causing considerable calamity. I think what the consensus has wrong is they’re underestimating the fiscal response and the resilience that we’re going to see out of China and that that’s not going to lead us into some sort of global recession.
The second is around the Fed, is that I think since ’08, ’09, the market has come to view the Fed as their best friend, and then with Jay Powell’s press conference the market seemed to react as though it lost its best friend, and now the Fed is the enemy. I think that’s an overreaction, is that the Fed is doing exactly what it is that they need to do and that we’re going to continue to have a constructive and supportive financial environment.
So while I don’t have a particular prediction around changes to quantitative tightening the balance sheet or rate structure, what we do have some confidence in is that financial conditions matter to this Fed, and so if financial conditions tighten, the Fed will respond.
Article by The Royce Funds
