Investment Climate April 2024: Wither the Interest Rate
The first quarter of 2024 ended with most major stock market indices in positive territory with large and mid-size indices up around 10% and smaller companies lagging, ending the quarter up only about 2-3%. The overhang of higher interest rates and lingering concerns about inflation continued to be a drag on smaller companies. This was, for sure, the major drag on our growth portfolios, while the more conservative dividend-paying companies held up much better than their smaller, more “growth-oriented” counterparts.
We can’t help but believe that the fixation on interest rates and inflation has missed a much broader reason for the relative underperformance of smaller companies. We think the environment for small company success has been hindered by the theme that we proposed in our last piece, “The Question of Our Time, Part VII” namely that onerous government regulation has made it much more difficult for small companies to compete against their larger, often more heavily capitalized counterparts.
For sure, this is not meant to be an excuse for business failure. However, as evidenced by what we have termed the “8000 to 4000” problem (the shrinkage in the number of public companies in the first two decades of the 21st century), it is quite clear that new company formation has been in a serious decline. And, yes, the SPAC/IPO phenomenon from 2018 to 2021 put the count back over 5000 public companies, but that is now waning again as the IPO market has all but ceased, and large to small M&A proliferates once again.
We do not believe 5% interest rates are an insurmountable hurdle for small companies, nor is 3% inflation (unfortunately, that has been the long-term average for most of the fiat-money regime). What is problematic is the onerous regulatory environment that hampers small companies’ ability to compete on a level playing field and makes it harder for them to access capital and grow their businesses.
What is needed is regulatory reform that gets bureaucrats out of the way of entrepreneurs. Reminiscent of the “Reagan Revolution” of the 1980s (but not necessarily the same tactics), the world needs government to back off. Unleash the creativity of individuals to create and grow. Frankly, this would drive an economic boom that would shortly solve the concerns over debt and spending that have rightly garnered the attention of many reason-minded observers of the economy. Roll back Sarbannes-Oxley (the IPO killer), and bring back free pricing of NASDAQ and OTC securities that gives securities dealers an incentive to make markets in small company stocks. Make the banking industry free and stop the “abundant reserves” monetary regime that insulates the mega-banks from consequences for bad risk decisions. Make short-selling illegal as we don’t need someone to borrow our stock and sell it for us to school bad management. We can do that on our own. If one can’t short private companies, one shouldn't be able to “gamble” on shorting public ones -- there is no economic value in it! We realize this last point is going to get us in trouble with many.
In spite of all of this, there are small companies that are extremely undervalued right now and are thriving in this difficult environment. We think that there will be “venture capital-like" returns in many of them. Should there be a seeing of the light on the part of the powers that be, this could unleash many more winners. While we are waiting, we will keep on searching for those that thrive anyway.
