It's not just Andrew “Twiggy” Forrest and his company, iron ore producer Fortescue Metals, which have benefited from the US Federal Reserve governor Ben Bernanke's decision to print money at the rate of knots in “QE3” and prop up commodity prices. It's also small cap fund managers.
The decision by the Federal Reserve to use “quantitative easing” again and effectively print money to buy $US40 billion ($38 million) of mortgage-backed securities every month until it sees an improvement in the jobless rate has almost certainly helped bankers over the line with their decision to extend a $4.26 billion credit life-line to iron ore producer Fortescue, which Forrest founded and in which he has a 32.8 per cent stake. Its stock was up 17 per cent yesterday.
You can bet that the gains for the high-risk stocks in the small caps realm will be much more than this after Bernanke & Co effectively guaranteed returns in the short-term. It's especially positive for the miners of hard commodities such as gold, copper and oil and gas that rely on global economic growth for price rises.
Macro-economics is important for stock-pickers. The majority of fund managers claim that their decisions are based on “bottom-up fundamentals” and that the bigger economic forces don't play a direct part as they are “stock-pickers” first and foremost.
You can't really claim to do this for miners, whose valuations are based on commodities prices. This makes the comments on the big picture by Issam Eid, a small-cap portfolio manager for Sigma Funds Management, so refreshing.
“The risk of the world imploding and going into a massive recession is now non-existent, at least for the next six to 18 months," he says. "In the long-term (quantitative easing) creates inflation, which is disastrous for everyone.
“We're buying gold, copper and oil and gas stocks and looking at contractors that are exposed to these sectors.”
And if China comes in and pumps money into its economy under its new leadership next year, it's also off to the races for the bulks — meaning iron ore and coal.
Domesticities are also important
The flip side to this story for many small caps outside of mining and mining services is the domestic economy. Here, although things aren't quite so straight-forward, there are definitely opportunities in those companies that are exposed to consumer spending, in the opinion of Radar.
Things are slowing down big time here and the official cash rate at 3.5 per cent is ripe for the cutting. In an environment of weakened commodities prices, the Australian dollar has held up, which is unprecedented. Normally the Aussie dollar would weaken in this situation, providing stimulus for exporters.
The answer lies in Australia's currency being one of the few with sovereign debt issues that have an AAA credit rating. A country like China knows the risk in holding too much US denominated debt.
The other big point is that the savings rate is at its highest rate since financial deregulation in the 1980s for both business and individuals. Added to this are governments at all levels hell-bent on cutting costs.
This can't go on for much longer and we believe the RBA will cut and cut hard to protect non-mining related sectors of the economy. Whether it happens in the next few months or in six to nine months' time is the question.
You can be sure that consumer-exposed small cap stocks will move very quickly in anticipation. And who knows, Harvey Norman might as well.
Radar is looking at small cap industrials that sell products directly to people because these are the ones that will benefit from aggressive cutting. We know that Eid & Co are also, and you should too.
Click here to access the fortnightly newsletter Under the Radar Report: Small Caps edited by Richard Hemming.