These are the kinds of companies you want to own: Dan Veru

Key Concepts

• Market Valuation: Assessing stock prices relative to earnings (P/E ratios).
• Mag7 Stocks: The seven largest tech companies dominating market returns (Nvidia, Apple, Microsoft, Alphabet, Amazon, Tesla, Meta).
• Russell 2000: A small-cap stock market index representing 2,000 smaller companies.
• Value Investing: Focusing on companies trading at a discount to their intrinsic value.
• Small/Mid-Cap Stocks: Companies with smaller market capitalization, potentially offering higher growth.
• Regional Banks: Smaller banks operating within specific geographic areas.
• Free Cash Flow: Cash a company generates after accounting for capital expenditures.
• Yield Curve: The difference in yields between short-term and long-term bonds (specifically the 2-year and 10-year Treasury yields).
• Inflation & Interest Rates: The rate at which the general level of prices for goods and services is rising, and the cost of borrowing money.

Market Broadening and Small-Cap Opportunities

Dan Veru, CIO of Palisades Capital Management, discussed the current market landscape, emphasizing a potential broadening of economic growth and investment opportunities beyond the dominant “Mag7” stocks. He highlighted that the Mag7 currently trade at 31 times earnings, while the S&P 500 averages 23 times earnings. However, when the S&P 500 is equal-weighted to diminish the influence of the Mag7, the valuation drops to approximately 18 times earnings. Small and mid-cap stocks are trading even lower, at 15 times earnings, suggesting potential value. Veru anticipates that tax legislation, improved regulation, and decreasing interest rates will accelerate earnings growth for these smaller companies at a faster rate than large-cap stocks.

Russell 2000 Analysis & Value Focus

The conversation then focused on the Russell 2000 index, which was on track for its fifth consecutive record. Veru cautioned against indiscriminate investment within the index, advising investors to prioritize profitability. He noted the Russell 2000 has experienced the second-longest period of underperformance relative to the S&P 500 since 1931, but a recent “clearance event” in April initiated a recovery. He stressed that the initial phase of this recovery was driven by low-quality, loss-making companies, and the current phase requires a greater focus on valuations.

He specifically recommended looking at value-focused ETFs like the Vanguard Russell 2000 Value ETF (VTWV), citing examples of companies within it like EchoStar, Heckler Mining, Cadence Bank, Commercial Metals, and Jackson Financial as representative of the desired profile.

Regional Banks & M&A Potential

Veru identified regional banks as particularly attractive, noting they trade at a discount to larger banks, historically trading at a premium. He attributed this to a more favorable regulatory environment and predicted increased merger and acquisition (M&A) activity within the sector. He believes consolidation will be a significant trend.

Technology Sector – A Different Landscape

Addressing concerns about the technology sector, Veru argued that comparing today’s tech companies to those of the 2000 tech bubble is inaccurate. He stated, “The quality of the companies at the tech bubble back then, when it really was a bubble, was extremely low quality. You can't compare the companies from then to today.” He emphasized that current tech giants generate substantial free cash flow, possess strong balance sheets, and have the capacity to invest heavily in areas like Artificial Intelligence (AI).

Macroeconomic Outlook & Bond Considerations

Regarding the broader macroeconomic picture, Veru acknowledged the positive signals from initial jobless claims, noting that a lower-than-expected number indicates a healthy labor market. However, he expressed caution regarding bonds, stating, “Bonds don't do well,” and predicting a sustained period of higher inflation and interest rates. He reasoned that this is necessary to fund real capital investments within the country, which require significant financial resources. He believes the conditions of the past decade – zero interest rates and zero inflation – are unlikely to return. The rising 2-year and 10-year Treasury yields were noted, with the 2-year yield reaching a five-week high.

Logical Connections

The discussion flowed logically from a broad market valuation assessment to a specific focus on small-cap opportunities within the Russell 2000. The emphasis on profitability and value investing within the Russell 2000 connected to the identification of attractive regional banks. The conversation then addressed the technology sector, contrasting it with the past to justify continued investment, before concluding with a macroeconomic outlook and cautionary note on bonds.

Synthesis/Conclusion

Dan Veru presented a bullish outlook for the broader market, particularly for small and mid-cap stocks, driven by favorable economic conditions and regulatory changes. He advocated for a value-focused approach, emphasizing profitability and strong balance sheets. While acknowledging positive macroeconomic indicators, he cautioned against complacency in the bond market, anticipating a sustained period of higher inflation and interest rates. The key takeaway is a shift in investment focus from the dominant “Mag7” stocks towards undervalued opportunities in smaller companies and specific sectors like regional banking.