• Should Investors be Deterred from Small Caps?  

    In our latest Wall Street Mood Monitor™, Chief Investment Officer John Riddle, highlights the decidedly negative sentiment on Wall Street as part of our three-factor model of revisions, earnings trends, and correlations. Here, we take a deeper look at revisions, specifically within the small cap universe.

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    In January, we discussed how analyst sentiment was at a six-year high as of the end of 2017. Here, we take a look at the small cap universe and see if that feeling has endured, or if analysts have reined in their expectations.

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    Lately, Value has not been very valuable within small cap stocks. Save for a couple of weeks last December, the Russell 2000 Value Index (RUJ) has underperformed its Russell 2000 Growth Index counterpart (RUO) on a rolling 13-week basis since February 2017.

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    This year’s NCAA tournament has seen its fair share of upsets. For example; a #11 seed made the final four—only the fourth time in tournament history. As I contemplated the implications on my bracket, my mind drifted off to what this suggests about investing, particularly in the Small Cap space.

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    A recent article in the Financial Analysts Journal® (subscription may be required) by Feng Gu and Baruch Lev titled, “Time to Change Your Investment Model”, analyzes the effectiveness of predicting earnings surprises. That is, knowing beforehand and owning stocks that meet or beat consensus estimates and shorting those that miss. Their contention is that abnormal returns to such predictions have diminished. The authors present the case that Generally Accepted Accounting Principles (“GAAP”) measurements, particularly earnings, have become less useful to analyze individual companies. Consequently, earnings surprises are less informative than they used to be, evidenced by reduced abnormal gains. As we mention often, earnings surprises, and even more so, analyst revisions, are very important to us.