Leuthold: current small cap valuations correlation wtih 14% forward returns

David_Snowball

In the March issue I'd mentioned the wisdom of diversifying about from domestic large growth. (Down 4.4% in the first four hours of the day, March 10 with all of the growth categories down 10+ percentage in three months.) Leuthold shared two bits of information today. First, they had decreased and are continuing to decrease their equity exposure. As of this morning (3/10), it hovers around 50% in their tactical portfolios. And (2) since the data since 1995, valuations for small caps at this level correlate with 14% annual returns over the next five years.

Quick screen for global and US small caps, ex-growth. Year-to-date, the winners have been Cambria Global Value ETF (up 17%), Brandes ISC (up 13.8%), Oakmark ISC (up 13%), Kopernik Global All-Cap (up 12.7%) and Dimensional International SCV ETF (up 12%). The best purely domestic SC funds are Aegis Value (up 5.3% and Longleaf SC (up 3.8%).

BenWP

In addition to Brandes International SC (BISAX), mentioned above, BIEAX (Brandes International Value) has clocked 18.23% for 3 years and 13.78% for 5 years. Since 2023, the clone of BIEAX, BINV, has pretty much matched its performance. I'm hoping the time-worn predictions about the return of SCs and international stocks may yet bear fruit.

FWIIW, I have committed money to Brandes, but they have yet to invite me to La Jolla for coffee. At least Disciplined Growth Investors sent me a spiffy box of candies, a welcome display of Midwestern niceness.

WABAC

We do love to attach faith to patterns.

yogibearbull

There is a line of thinking that the current small-caps (SCs) are different from those of the past.

Many companies are remaining private for much longer - several are unicorns. Money from private-equity and venture-capital is easy. There are few public reporting obligations. What's not to like?

Many mutual fund firms (Fido, etc) are also able to tap into the private-equity market.

Private companies have another problem - some are just too big for 100% public IPOs, so those few that do the IPOs do it for only 10-20%, and then their insiders wait to unload the rest later gradually (if they can).

At the same time, good SCs that grew graduated into MCs/LCs.

So, what remains is a bad SC bunch with some 35-40% of R2000 operating at loss. The OP chart is for better SP SC 600.

Many SCs cannot access the bond market, so they rely on bank-loans.

SCs may have become like a dwindling pond without refreshing supply.

30-yr charts don't capture this shift.

Repeated failed SC rallies have only frustrated the investors.

While I have a small position in SCs, I hesitate to load up the truck because this time may be different (for SCs). Total market etf VTI is 72% LC, 20% MC, 8% SC. The global total market etf VT is even more lopsided with 74% LC, 19% MC, 6% SC (so, the LC tilt isn't just a US issue, but a global issue).

Edmond

yogi, agreed. Another 'twist' on SC these days, is that the Mag7 may be active acquirers sooner rather than later of the best/brightest of the SCs in the tech space specifically.

Certainly, for those inclined to hunt in the SC space, I think it makes sense to not use unmanaged (i.e. dumb) market-cap weighted index products. Find either an active manager, or a smart-beta product that suits your investment philosophy -- notably one which avoids the money-losers in the SC index.

Disclosure, I've a recently established position in SC ETF "DFAT".

FD1000

Unfortunately, investing based on valuation have been wrong for over 10 years now.
GMO seven year forecast from 12.31.2010 was a huge miss and so was Prof Shiller from 2012 based on PE10.

See the above forecasts and many others.
https://fd1000.freeforums.net/thread/13/wall-shame-worse-experts-predictions