Expert reveals the upside for small-caps this year

Yahoo Finance’s Akiko Fujita and Zack Guzman break down today’s market action with Eric Marshall, Hodges Small Cap Fund Portfolio Manager.

Video Transcript

AKIKO FUJITA: Let's bring in our first guest for the hour. We've got Eric Marshall, Hodges Small Cap Fund portfolio manager. And Eric, I want to get to your picks in just a bit, but I'd love to get your broad overview of what we're seeing in the markets today.

The potential now for the Senate to move on this $1.9 trillion stimulus bill. You've got positive news coming through on the vaccine with President Biden saying there will be enough vaccines for all Americans by May. And yet it doesn't seem like that has been really supportive, at least in the market. The NASDAQ down about 1%, the S&P 500 down 3/10. What does that tell you?

ERIC MARSHALL: Well, I think the market is really trying to discount what all this additional stimulus could mean, once consumption picks up in a post-pandemic environment. Also, we have interest rates starting to go up for the first time in a while. And that's really created a rotation into some of the more cyclical value related stocks. And also, we're seeing small caps continue to outperform year to date.

ZACK GUZMAN: Now when you look at the small caps, what do you like over there? Because year to date, the Russell up 15%. What standout-- is it kind of the same way you'd be playing some of the bigger cap names as well and steering clear maybe of some of those tech names? Or how do you see it playing out?

ERIC MARSHALL: Well, I think if you look at the small caps, they tend to be more economically sensitive companies. In a lot of cases, their earnings were hurt more by the pandemic. And the earnings recovery that we think will be under way in 2021 will be even more profound within small cap stocks. So, in the Hodges Small Cap Fund, we're really focused on relative and absolute value right now. And we think you can find that in a lot of the more economically sensitive areas within banks, within industrials, transports, and energy.

AKIKO FUJITA: One of the reasons you've highlighted that you like small caps is the potential for M&A. And I'd be curious to just have you walk through the thinking there because this is something we've heard from a lot of guests, not necessarily about just the small cap names, but the potential for consolidation moving forward. What particular sectors are you eyeing that you think are really ripe for consolidation right now?

ERIC MARSHALL: Well, you know, during 2020, a lot of companies really took a hiatus on M&A activity. So we've actually started to see that pick up. I mean, we had, I guess, Apollo bought Michael's this morning. That was one of our portfolio companies in the Hodges Small Cap Fund.

But we think you'll see more and more strategic acquisitions as people try to make up for the lack of capital investment in their businesses over during the pandemic. They'll go out and make strategic acquisitions to kind of externally make up for that lack of organic growth over the last year.

So we think M&A could pick up. There's a lot of pent-up demand out there. Balance sheets are in relatively good shape to do that. And interest rates, although they've come up, they're still at very attractive levels to see that type of activity. So we think that's something that could buoy multiples, especially for smaller companies.

ZACK GUZMAN: All right, let's get into some individual names here on your list. Hamilton Beach brands, I think all the time, I've been doing this. You're the first one to come on here to talk about the big bad boy blender company here. So explain that one to me and the thesis around it.

ERIC MARSHALL: Yeah, this is a company that makes specialty houseware appliances. They've recently entered into some strategic agreements to-- with the Wolf brand to introduce Wolf-branded small appliances, like blenders and toasters and those type of things.

But this is really a cash flow machine that's benefiting from people spending more money on their houses and their kitchens. The company generates a lot of cash flow, and they actually yield over 4% right here. So that's one that we think is really underneath the radar that represents an attractive absolute value in this market.

AKIKO FUJITA: Another name that you've been eyeing, Cleveland Cliffs, the ticker CLF there. How do you think they are likely to benefit on the back of these inflationary pressures building up?

ERIC MARSHALL: Yeah, believe it or not, this was a small cap stock not that long ago. But the company has really gone through a transformation. We think that they will benefit from some of the inflationary pressures that are built up in the market because of the pent-up consumption that we're going to see.

But we think the company has strategically positioned itself through a couple strategic acquisitions over the last few years to really create tremendous value for shareholders. We see them as having over $2 of earnings power over the next couple of years. And we could easily see this stock trade in the mid to upper 20s.

ZACK GUZMAN: And lastly, just for me, I mean, we've kind of talked about the jitters that we saw around yields rising last week. Today, yields up again, the moves clearly not to anywhere close to what we saw last week. But what do you make of maybe just that pressure there? Because the VIX necessarily hasn't, maybe in some people's opinion, shot up as high as maybe you'd expect, given what we saw last week. What's your take on maybe some of those catalysts, unforeseen circumstances, and the pressure right now of valuations where we're at, maybe some of the negative concerns that could mount?

ERIC MARSHALL: Well, certainly higher interest rates will result in lower multiples. And I think in a zero rate environment, which we were in during the depths of the pandemic, it was very difficult to come up with a present value of future earnings and cash flow. But as interest rates move back up, I think that companies that generate real earnings and cash flow will command reasonable multiples. And I think that's one reason that you see that rotation right now into value stocks versus the hyper growth stocks that really led the market through much of last year.