We see the return of volatility as an opportunity. Domestic stock valuations still seem reasonable relative to the recent pull back in interest rates with the S&P 500 Index trading around 17X forward earnings estimates according to FactSet. The inverse of the current PE multiple is an earnings-yield of +6%, compared to the 10-year treasury yield of 1.6%. We believe the relationship between the earnings yield on stocks and interest rates currently indicates that the potential reward for holding stocks outweighs the underlying downside risk as long as earnings expectations materialize in the months ahead.
With the divergence of small caps relative to the broader market representing their largest divergence in 16 years, we see small caps as ripe for active managers to take advantage of mispricing in U.S. equity markets. Although small, last week, our investment team held discussions with over 70 small cap management teams, and generally came away with a tone of cautious optimism regarding the prospects for growth in the remainder of the year despite all the noise regarding trade uncertainty.
Small caps have diverged in recent months as the S&P 500 has been hitting new highs. There have been only three times in history that a difference of more than -10% has occurred (1985, 1991, 1998). In all three of these instances, small caps caught back up in the following 12 months. We believe attractive relative valuations among small caps will play a role in small caps performing in the next couple of quarters.
A few areas that we are finding opportunities include: housing related stock, beaten down consumer names and industrials. So we’re finding value in some overlooked names.
Century Communities (CCS) – Is an entry level home builder that is in the very early stages of growth and is in the best market – entry level. The prices are lower for first time home buyers. They’re in the best areas and sell their homes in 17 states across the West, Mountain, Texas and Southeast U.S. regions. Between now and 2024, we’re going to need these homes as Millennials, which is the biggest group ever, will start to buy homes. We think the next 5 years will be a great opportunity to own housing.
American Airlines (AAL) – Is the worst performing airline stock but we see positive catalysts coming for this airline. The group as a whole has been underperforming but AAL has an easier path to fixing itself once the issues with Boeing are resolved.
Generac Holdings Inc (GNRC) – Is a leading generator manufacturer . This is an energy, housing and 5G play. Generators are becoming more common place as more and more people are buying them. We think this is a trend that is going to continue
Disclosures: Craig Hodges personally owns all of these stocks indirectly though his mutual funds. The firm owns all of these stocks directly or indirectly though their mutual funds. No investment banking relationships.