The Gannon Report

Famed financier and investor George Soros recently spoke at a conference I attended in New York.  To say that he was bearish is an understatement.  Mr. Soros believes that a second, and more severe, wave of economic weakness will be felt as consumers and businesses unwind a "super bubble that began in 1980" with the proliferation of leverage and indebtedness by the consumer.  Interestingly, when asked by an audience member about where to invest now, Soros stated that "in this period of macro markets it is very difficult to make money, except in the short term."  

Our expertise is in smaller-company stock investing. We typically have little, if anything, to say about the economy in general, and even less about large-scale, macro trends such as  "super bubbles," but it's always worthwhile for us to hear the viewpoints of world-renowned investors such as Mr. Soros, even if we would give a dramatically different answer to the question about where one might think about investing. To us, opportunities abound in the smaller-company equity world, making the current environment among the most compelling that we have seen in at least the last six years.

Why are we at Royce confident about the long-term prospects for smaller companies? First, there is the extremity of the sell-off that began in the second half of 2007 before picking up steam in the first quarter of this year.  Typically, these kinds of significant declines create what we view as terrific long-term opportunities. From the most recent small-cap peak on 7/13/07 through 3/10/08, the Russell 2000 declined more than 24%. During this period, more than 900 companies in the Russell 2000 lost more than 30%, 642 declined more than 40%, and 391 were off more than 50%.  Moreover, in the most recent rally from the low on 3/10/08 through 5/15/08, the small-cap index rose 15.8%, and yet there were 102 companies in the index that were down 30% or more.

As we have stated before, smaller companies form an "evergreen" asset class because of initial public offerings, spinoffs and larger companies dropping into the space. In addition, there are almost always a large number of out-of-favor companies with extremely low expectations and/or little coverage from Wall Street.  While we are generally able to find individual companies that we think represent excellent potential, there are also periods in which entire industries or even sectors present ample attractive risk/reward opportunities. Currently, many companies in the technology and consumer discretionary sectors have been playing precisely this role. 

With an eye towards absolute performance and a focus on managing risk, opportunities in smaller companies are generally constant.  To be sure, there are times when certain sectors and companies appear overvalued. However, history has shown there to be a continual stream of compelling values in smaller companies most of the time. Although Mr. Soros is less optimistic about the wider world and today's investment opportunities, we remain enthused about smaller companies and what they will likely offer over the long term.

Stay tuned…
FDG