As the month of June approaches, millions of investors will be wondering whether the Federal Reserve will continue its policy known as Quantitative Easing. Last month, Dr. Bernanke told us that current monetary policy, which includes short term interest rates staying at 0%, "... will continue through at least the next two meetings."
That would take it through "at least" the August 9 meeting, yet the news media and many economists are wringing their hands that without the Fed's ongoing "goosing" of the economy, the market will sorely correct The fact is that the S&P 500 has traded almost sideways since mid-February, when the SPX moved close to the 1,333 level. That was about double the March 2009 low. For the past three and a half months, there has been a lot of media-driven trading above and below the 1,333 level. May has been an unremarkable month, with the SPX down 2.4%.
During this period, worries are mounting about the domestic economy entering another recession, and some expect just that by the end of the year. The other usual suspects include concerns about slowing world growth, driven by central-bank tightening in China and the continued debt crisis in Europe. This adjustment in expectations has stifled stocks recently. But, as contrarians know, lower expectations often set the stage for upside surprises and rising stock prices in the future.
The Russell 2000 index of small-cap stocks has really struggled of late, as hedge funds have been fleeing small-cap names deemed "riskier" in favor of more defensive, larger-cap stocks like Johnson & Johnson (NYSE:JNJ), Heinz (HNZ), Level 3 Communications (NASDAQ:LVLT), Intel (NASDAQ:INTC) and General Electric (NYSE:GE). The talking heads on TV as well as the financial media have also pointed out that brokers are "scared to death," especially of small-cap stocks. With sentiment this negative, a return of small-cap leadership seems likely in the near future.
No matter what the Fed does, the economic "gloom-and-doom" will force it sooner than later to keep interest rates low and encourage some inflationary expansion. This means we're going to still have a number of stocks that will do well. My firm belief is that market advances will be led by small-cap and mid-cap equities in the weeks and months ahead.
If you are going to put money into the market at this juncture, consider names deemed "risky"at the present time. Those would include oil, with names like Frontier Oil (NYSE:FTO) and Advantage Oil & Gas (NYSE:AAV); precious metals companies like silver producer Silvercorp (SVM) and Alexco Resource (NYSEMKT:AXU); gold producers Seabridge Gold (NYSEMKT:SA) and Exeter Resource (NYSEMKT:XRA); and gold royalty company Royal Gold (NASDAQ:RGLD), especially attractive below $54 a share.
There are some small-cap business development companies (BDCs)with huge dividend payouts (north of 10%) such as Prospect Capital Corp. (NASDAQ:PSEC). This private equity firm is also a mezzanine finance firm that specializes in late venture, middle market, mature, mezzanine, buyouts, recapitalizations, growth capital, development, and bridge transactions. I like it below $12 a share.
A similar BDC is Fifth Street Finance Corp. (NYSE:FSC) with a market cap of $817 million, which specializes in investments in middle market, bridge financing, first and second lien debt financing, expansions, acquisitions, add-on acquisitions, recapitalizations, and management buyouts in small and mid-sized companies. FSC mainly seeks to invest in education services, business services, retail and consumer, manufacturing, food and restaurants, construction and engineering, distribution and logistics, and media and advertising sectors. FSC is attractively priced at the present time with a 10.4% dividend yield.
The small-cap trade has become less crowded in recent weeks, as hedge fund managers flee to "safer" names and take a more defensive stance. Companies with healthy balance sheets, increasing sales growth, net earnings of 20% or better in two out of the last three years, rich resource deposits, innovative products and an ever-increasing product pipeline will thrive no matter what the Fed does for the rest of 2011.
Look for small and mid-cap companies that fit this criteria (throw in quarterly earnings growth of 25% or better in their most recent quarters and you'll eliminate 90% of those that are publicly traded). Be especially mindful of those healthy, productive companies that have been oversold and undervalued for no substantial reasons besides fear and worry.
Disclosure: I am long AAV, INTC, SVM, AXU, PSEC, FSC, XRA.