January 19, 2023

The S&P 600 Small Cap Index hit a 2022 closing low of 1,064 on September 26. On November 11 it moved back above its 200-day moving average line and closed at 1,232. That was a 16% move off the low.

The index then moved sideways for a few weeks before dropping back below both its 50- and 200-day moving average lines in mid-December. At that point, the index found support at 1,135, roughly 7% above the November lows.

After the favorable NFIB Small Business Survey (lowered the risk of wage price spiral) the S&P 600 Index moved back above its converging 50- and 200-day lines last Tuesday. And with CPI inflation coming in as expected mid-week the index kept walking higher.

Yesterday morning’s PPI inflation report (lower than expected, which is good) drove an early morning rally and our index popped early, then ran into a wall at 1,250, right where small caps peaked in both mid-November and early December.

The same directional moves have shown up in the chart of the S&P 500 Index. But large caps have not shown the same conviction as the small-cap index. The S&P 500 keeps bumping up against the underside of its 200-day moving average line and falling back, and this recent rally, to about 4,000, fell short of the December high of 4,100 whereas small caps revisited their December high.

Given that recent inflation data has been encouraging and the 10-year yield just fell to a four-month low yesterday (to 3.38%) wouldn’t it seem that both the small and large-cap indices should be able to move above their December highs?

On the one hand, yes, I think it should.

On the other hand, as concerns about inflation are easing, concerns about recession are rising. That’s pushing down forward revenue and earnings estimates, both of which are major drivers of valuations and therefore stock prices.

Yesterday’s PPI inflation data was another good sign for inflation. As the following chart from Yardeni research shows, the PPI indexes (total, goods and services) for personal consumption are all falling.

But … yesterday’s December retail sales data was a little weak. And retailers are having to discount to clear out inventory.

Bottom line, there are both positives and negatives to falling inflation, depending on your perspective. The Fed’s policies have pruned the undergrowth and the path to a soft-landing scenario is now just a little bit wider.

But it’s not a foregone conclusion. And that’s why the stock market isn’t racing higher even as inflation seems to be racing lower and the Fed appears to be one (or two) 25bps hikes away from the end of this historic hiking cycle.

I continue to think the overall environment for investors, especially small-cap investors, is better now than it has been for many months.

Small-cap valuations are down, much lower than large-cap valuations. And the stock market tends to look forward about a year, which means it’s starting to look past the (expected) final interest rate hike(s) and, possibly, even a modest recession in 2023.

But, we have a big hurdle in front of us in the form of Q4 earnings season. Key to the stock market’s health will be guidance on 2023.

All of this is why we’re not getting more aggressive right now, even though I think the market could be higher in a month or two. We just need more information. It will come soon enough as our companies will start reporting in the first ten days of February.

Enjoy the relative calm of the next two weeks. Then get ready for the FOMC meeting on February 1 and earnings reports soon after!

Recent Changes
None

Updates

Enovix (ENVX) hasn’t done much this week and news flow has dried up after a busy stretch for management. Recall that last week Canaccord Genuity jumped on ENVX with a buy rating and 20 price target, and management sat down with JPMorgan to discuss the current state of the business. Highlights from that discussion are that the Fab1 line shows batteries can be made at scale and that Gen2 is where more automation will come into play. Gen2 equipment is still expected in the back half of this year. Enovix will likely need to raise capital in the back half of 2023 to fund construction of new manufacturing lines. Execution will increase its options on how best to do that. Keeping at hold. HOLD

Flywire (FLYW) continues to act well in the wake of the buyout of competitor Paya Holdings (PAYA) by Nuvei (NVEI). Late last week Wells Fargo (WFC) boosted their price target on FLYW to 30 from 27. BUY

Huron Consulting (HURN) sold off to about 67 a couple weeks ago and climbed out of that little hole last week. After a 5% dip yesterday, shares are back near 68. The stock has now been below its 50-day line since mid-December. I’d like to see a little more momentum in the name. Maybe the Q4 report will help with that, though it’s not due out until around February 24. The stock reacted well to the last three earnings reports. BUY

Inspire Medical Systems (INSP) is holding up nicely above the 250 level. A recent price target increase from KeyBank (from 287 to 303) is just the latest endorsement of the stock. Recall that early last week management released preliminary Q4 results that imply full-year 2022 revenue of $407.7 million (+75%) versus consensus at $390 million (+67%). The company is hiking selling prices in the U.S., submitting Inspire 5 for approval and expanding more overseas (European revenue already ramping). HOLD TWO THIRDS

Intapp (INTA) is still looking good as shares creep closer to the May high of 28. The company sells cloud-based software for the global professional and financial services industry. Management keeps raising guidance, despite a challenging macro backdrop. The most recent update was in November when they called for $332 to $336 in fiscal 2023 revenue. Fiscal Q2 results should be out in February. Both Credit Suisse and Oppenheimer have raised their price target recently, to 33 and 30, respectively (stock at 2). BUY HALF

Procept BioRobotics (PRCT) was sold last week to lock in a gain of about 40% on our remaining half-sized position. I’ll continue to keep an eye on the name. SOLD

Rani Therapeutics (RANI) recently stated that, based on an FDA meeting, a simplified/accelerated approval process may be suitable for RT-102, the RaniPill Go capsule containing parathyroid hormone (PTH) for treatment of osteoporosis. Management also announced a collaboration with Celltrion, which will supply the ustekinumab biosimilar (CT-P43) needed for RT-111 (for psoriasis). I included the following slide of the pipeline and potential milestones last week and am doing it again today as it offers such a good perspective of what’s going on here. HOLD

Repligen (RGEN) gave an update last week at the JPMorgan conference, and nothing has changed since. Management continues to see another quarter or two of COVID-related inventory destocking and 15% to 20% growth in the base business this year. A 5% increase in prices and a softening dollar should provide a modest margin boost, to around 56%. A decent early look at Q4 results from larger peer Danaher (DHR) last week has helped the entire bioprocessing space and helped push RGEN back above 180 this week. HOLD

Sprout Social (SPT) continues to move sideways in the 47 to 70 trading range that’s held since summer. Looking at software valuations, higher-growth names (i.e., +20%) now trade with an EV/Forward Revenue multiple of around 6.2, well below the five-year trailing average of 13.8. Granted, 2020 and 2021 saw a max valuation of 27.5 which skewed that average to the high side when revenues for many software stocks exploded. But if we adjust for growth (i.e., use the EV/Forward Revenue/Avg. 2-Year Growth multiple) we see software stocks trading well below their average multiple from the last five years as well as the 2014 to 2018 period. This group of stocks will do a lot better when ten-year yields come down (hit a four-month low yesterday). Sprout will report Q4 results on February 21. HOLD HALF

TransMedics Group (TMDX) is trading near an all-time high. Investors are clearly expecting the track record of solid execution over the last two quarters to continue. Confirmation that things continue to go well would likely help the stock move higher after Q4 results. Management is quadrupling production capacity and doubling assembly staff, all of which should be paying dividends by this coming summer. With utilization of the National OCS Program (NOP) rising and annualized revenue ending 2022 just above $100 million, there should be room for management to continue with a beat-and-raise cadence. The launch of heart and liver over the last year are big helps. HOLD THREE QUARTERS

Xometry (XMTR) continues to get knocked around by weak manufacturing data. We’re awaiting an update from management – most likely the Q4 earnings report – showing they’ve resolved the Q3 issues on the platform that led to Xometry leaving money on the table when matching buyers and sellers. With a lot of bad news priced in, the stock seems to have considerable upside this year so we’ll hang in there. Revenue is seen rising 33% in 2023. HOLD

Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks.