Yahoo Finance

With the Fed's jumbo-sized rate cut, at least the first of them, now in the rearview mirror, it could be small caps time to shine. Historically, after rate cuts, all market sectors do tend to rally, but small caps have often outperformed their larger cap peers. With just a few minutes left till the closing bell on Wall Street, we're looking at how to play small cap stocks with the Yahoo Finance Playbook. And joining us is Josh Bennett, Senior Portfolio Manager and Director of Research at Alger. Thank you so much for being here.

Thank you for having me.

So, we've been talking a lot about small caps all this year. People have been saying, here come the small caps, here come the small caps, here come the small caps.

Yes.

Are they coming now? Are they, is this it?

We think the setup is pretty good for small caps now. And I know people have been saying that for a while. But if you think about it, beginning with the rate cuts, which already feel like, I mean, it was a week, a little over a week ago, but it already feels like a lifetime of news that we've seen since then. Uh, historically you've seen that when rates begin, when the rate easing cycle begins, you see small caps begin to really outperform. So, um, it didn't matter to us whether it was 50 basis points or 25 basis points. The fact is as the easing cycle begins, we should see that as favorable for small caps. Expanding on that a bit, if you look at small caps over the longer term, what we've seen is historically you've seen small caps trade at about a 10% premium to the large cap index. And what you're seeing now is you're seeing small caps just off 20-year lows in terms of relative valuation to large cap stocks. So valuation setup is interesting. We're likely entering a rate easing cycle, whether it's 25 bips in the next cycle or not, we don't mind. It does feel like small caps are positioned to outperform.

Do I have, Josh, do I as investor, do I have to believe in the soft landing scenario before I move into small caps?

I don't think you have to. Certainly the soft landing would help small caps. Um, if we got into tough times, the portfolio that we manage at Alger called the Alger Weatherby Specialized Growth has a diverse holding of 50 names, and some of those names serve as ballast to the portfolio. I'm happy to talk about those later. Um, but I don't think you have to believe in the small in the soft landing. It does feel like that's what we're headed to. If by chance we avoid, we don't get the soft landing and we enter some sort of recessionary period, we have names in the portfolio that, and this is great, what's great about small cap, they can manage their business in a way to manage through uncertain times.

Small isn't weak, is what you're saying?

Small is not weak. And I think that's, it's interesting. A lot of people think that small cap companies don't have the strength, but when you look at where we operate in the small cap segment, we're looking for the highest quality small cap growth names that we can find. So oftentimes, instead of thinking about small cap names as, you know, smaller than large and therefore weak, we think of within small cap and SMID cap, which is the area that we invest, we look for the best, highest quality companies. Oftentimes they're competing against local mom and pops or regional players. They're not necessarily competing against the large caps. So they're actually better capitalized, better managed with more well thought out strategies.

Well, and it's interesting you say that because I well remember Savita Subramanian over at, um, Bank of America cautioning people on going too enthusiastically into small caps because she said a lot of them don't make money, right? Maybe a higher percentage than say of the S&P 500 don't turn a profit. So it seems to me if you're talking higher quality, they probably make a profit is probably one of your criteria.

Yes, in the vast majority of cases, the companies that we're looking are profitable. There are some cases where a company might not be profitable because they're investing heavily in technology, or they're investing in their sales force, they're kind of taking steps to position for future growth. But it's not like once they turn profitable, we're going to buy them at that point. We're positioning for companies that we think from a quality standpoint are likely to generate earnings and free cash flow within the next three to five years, not five, 10 years out.

Let's talk about some of those names, Josh. Ollie's, why is that a buy here?

Yeah. Ollie's is a retail closeout player. So they're the largest player in the closeout industry. This is an enormous industry, $300 billion in closeout, and over 200 billion of that is non-apparel, which is where Ollie's plays. So they don't compete with TJX, they don't compete with Marshalls. They're a large player where they do a lot of consumer CPG, so consumer products for people. And why is Ollie's a buy now? Because the consumer is looking for value more than they ever have before.

Let me ask you though, because I also think of say a Dollar General and Family Dollar and Dollar Tree in that space, right? They've not been doing great.

They have not done well.

So talk to me about the differences between Ollie's and and those guys.

Sure. Yeah, Ollie's is different in that they know very much what they focus on in terms of what their product mix is going to be. So for example, um, they they don't sell a lot of the housewares, a lot of the patio furniture. They have that, but they've been focusing their attention on the products that people need right now, which is more C, consumer packaged goods that they, they know they need right now. Room air, believe it or not, was a very strong segment where people need air conditioners, they need room fans. So Ollie's knows where the consumer is going, and they know how to focus kind of on, on what the consumer actually needs.

What about, here's another one. I'm just going to get your take on RXO, which had a nice run. It's popped about 20% already this year.

Sure.

Yeah. RXO is a truck brokerage company. So what that means is they don't own a lot of trucks, but they are the network that combines truck capacity where there are like 600,000 trucks that are out there on the roads with the truck demand, which would be companies that need to move stuff around. RXO owns the network. They've invested heavily, millions of dollars, hundreds of millions of dollars in their network. They're using AI technology in that network to basically match capacity with demand. So RXO should benefit as the industrial cycle begins to pick up. They'll see that benefit. I know that earlier in the day you were talking about the ports and the strikes there. If that becomes a problem, you need to move products around in other ways. That's where RXO really shines is they understand the network, they can match capacity with demand, high quality company, excellent management team, and we think they has years to go in terms of running.

Josh, great to have you on the show with those picks. Appreciate it.

Thank you so much. I appreciate it.