transcript

Speaker 1:
[00:05] This is The Markets. I'm Chris Hussey, and today is Thursday, April 23rd, and my guest is Greg Tuorto, who is head of the Small and Smidcap team in Goldman Sachs Asset Management. Greg, thanks so much for joining us.

Speaker 2:
[00:18] Thanks for having me.

Speaker 1:
[00:19] All right, Greg, an interesting time here for Small Caps. You know, the world has really gone mega cap tech, and yet at the same time, we've seen some Small Cap outperformance. What exactly is going on here? Is it still a good time to be in the Small Cap space?

Speaker 2:
[00:34] We think so. We think it's been three or four tough years in the Small Cap space, starting when the Fed started raising rates, and we really haven't gotten the tailwind fully from the cutting in rates you expect. We're starting to see a nice earning cycle in Small Caps. We think it'll be a lot more powerful than the large cap earning cycle. We also think they're a lot cheaper, about 25%, 30% cheaper than large caps, plus you have the optionality in the IPO market, which should help. And M&A is starting to pick up, which is also a really nice tailwind for the small cap market.

Speaker 1:
[01:05] So lower rates, better M&A, creating a little bit of a rotation in the small caps now, is that what has been driving this year-to-date outperformance?

Speaker 2:
[01:14] We think so. We think that there's also a little bit of animal spirits. There can be big moves that come in the small cap market that you can capture both alpha and beta. I also think if you want to put on your stock trader's almanac hat, the Yale Hirsch Guide, when you have a really nice move, like small caps are up 10% in January. Usually, that means it's going to be a pretty nice absolute return year, so that brings money back in. There hasn't been any inflows in the small cap space in a number of years. We're starting to hear that from clients who are really interested to come back into the space after having been out of it for a number of years.

Speaker 1:
[01:50] Let me explore that animal spirits comment because underlying and animal spirits is the notion that the economy is actually doing even better than we think it is. And yet we're in the middle of an energy crisis. How do small caps sort of shape up in an energy crisis? Are they positioned okay here?

Speaker 2:
[02:07] I think so. I do think that we have to watch that economic output and the underlying parts of it really closely. The small cap space is not as economically kind of sensitive as it once was. I do think that the energy side of it is quite small. And the transportation sector is the one you'd watch, the truckers and places like that, where they actually have to pay those prices that we see on the pump as we drive into work every day. I do think that some of the other areas have taken up some of the oxygen. Tech, biotech has done well. I think generally speaking, the consumer, John Flood, one of your former guests, was talking about the consumer this morning being an area that's really been underwhelming. We like a lot of the consumer names, and I do think that that piece of it is a sign that the underlying health might be better than we think it is for the economy.

Speaker 1:
[02:59] Yeah, I know. Good point, Flood. The FOGO, he has been thinking that maybe the consumer is ready to go again. Let me explore that tech comment you made, though, because AI is also a big theme in the market, and I don't think of small cap stocks as being the cutting edge of AI. How are they shaped up in an AI world?

Speaker 2:
[03:14] It's interesting. The moonshot hype cycle at the front end is an interesting place to be, but I do think that the picks and shovels side can be a little bit more of a long duration way to kind of harvest some gains, and I think that if you look at semiconductor cap equipment, which was nowhere two years ago and now is a leading sector in the market, and some of this optical connectivity that needs to connect these data centers together, there's a lot of opportunities there, a lot of ways to play it, a lot of different flavors of things to invest in, so I do think that this can be good even if software doesn't join the party as it hasn't for the past, say, three, six months.

Speaker 1:
[03:52] Yeah, no, it's a great point about the picks and shovels, and by picks and shovels, you mean the companies that can build the data centers, build the compute power.

Speaker 2:
[04:00] And be the components inside of it that kind of drive this stuff forward. I mean, a lot of, you know, the interesting thing is memory, right? We didn't think about memory as an expense, and it didn't kind of get to the headlines until people started looking at iPhone 17s, and I mean, why are they more expensive? Memory costs more, and memory costs more because you're using a lot of memory in these large language models as so much as being stored both near line and sort of in the data center. So we think that there's a lot of ways, not just the direct memory plays, you know, whether it's, you know, kind of the big guys or even the people who are trying to help them build more memory. So, you know, like the semi-cap guys who do that.

Speaker 1:
[04:36] Yeah, it makes a lot of sense. All right, you mentioned previously rates as being one of the catalysts here that might be going on here, but I kind of think of the rates market now as sort of an, I'm not sure which direction of rates here is. So now when you think about rates going forward, are we in the right exposure for small caps and rates?

Speaker 2:
[04:54] I think on the banking side, the smaller bank side, I do think that things have calmed down a bit, but not as much as they would like. The smaller banks are still, in some cases, you know, fighting for deposits. In that sense, rates are probably not low enough for them to differentiate. So we don't have a big bet on the banking side. I think that there are other parts of the chain, maybe on the payment side or on the insurance side, where you're seeing a little bit more of relief, where some of these things sort of at the margin can be drivers, the rate side can be a driver, or at least kind of not a headwind to them. So I think that that piece of it is still TBD. We would love to see rates become a little bit less in the spectrum, in terms of what we look at. The financial conditions, generally speaking, are pretty easy. You know, spreads have not been crazy. We haven't seen any accidents in private credit, you know, even though we've been watching it for months. And so that's good. So I think that, you know, generally speaking, it would be nice to see a cut, but not surprised if we don't get one in the near term.

Speaker 1:
[05:56] Yeah, no, great point. All right, last one on the fundamentals. I do think of this as sort of a domestic index, the Russell 2000. I think of a lot of the moves like higher tariffs trying to bring manufacturing back on shore. How is the sector, the index shaped up for a manufacturing resurgence in America?

Speaker 2:
[06:16] There's a couple of areas. You know, I mentioned semi and semi cap equipment. I think that that's one area. I think another area is on the defense side. We've had a lot of innovative companies go public, you know, especially even recently on the defense side. And it's not all drones. Some of it's just the components that you need to kind of power these things, connect that drone that's flying around back to a ground station so you can get the data. So I do think that's an area where you're seeing a lot of, you know, sort of, you know, built here, you know, type of innovation. That's one part of it. I think the other part of it too, that you've seen some innovation is, you know, kind of in biotech, interestingly enough. Biotech had a big boom in 2020-2021, and it's been sort of dead since then. We've had some M&A activity, and that's led to what we think of as a gradual beginning of the IPO cycle, where a lot of these, you know, a lot of these companies who are, you know, led by people who have done it once or twice before, or are looking to sort of, you know, kind of what is done well in the US and what areas, you know, are a little bit under followed. And that should be an area we think that, you know, could be able to exploit the, you know, kind of the America theme that is underlying small caps.

Speaker 1:
[07:23] Yeah, marry that to innovation, and you've got a real secular winner. All right, let's put a bow on it. What's the trade?

Speaker 2:
[07:30] Biotech, I like biotech. You know, I'll talk my book there, Semi and Semi Cap, you know, and that defense space, you know, I think this, we haven't seen innovation in defense in a very, very long time. And I do think that, you know, it's, you know, it sounds somewhat self-serving to kind of look and see what's going on and try to make money off of it. I understand that, but I do think that there's a, you know, a big change going on in the way we spend money in the defense industry.

Speaker 1:
[07:55] Yeah, it's so cool. In a mega cap world, you're going to have all these smaller cap companies that have to feed into that supply chain. All right, next week, believe it or not, we're going to turn the page on April. We're going to go into May. We'll also have the height of earnings season. What are you watching for next week and the week ahead?

Speaker 2:
[08:10] Earnings is going to be critical. I do think you're going to have some of these companies that are very well set up. And I do think you have to make sure that the expectations match the reality. We've seen some healthcare be a little bit weaker. You know, I think we've seen some industrials be a little bit stronger so far. You know, tech is also interesting, because, you know, talk in my book again, Semi and SemiCap have done well, software not so much. So I think that you need the continuation of the software side, but it would be nice to get some stability in software, so people take their foot off the neck of that asset class, because it's just been terrible for so long. The consumer, you know, I think the data is starting to recover from the initial stages of the war. So if that can continue and just see, like, you know, people are continuing to spend at restaurants and at retailers, that should be good as well. The data would indicate that it should be. We just need to see the proof points of it before you go forward.

Speaker 1:
[09:01] Whole lot of data, no question. But the real question, of course, is the Knicks. It's a big week next week for the Knicks. Can they get out of the first round?

Speaker 2:
[09:08] I think so. I mean, it's a much more balanced team that they've had in a number of years. It looks like a winning team.

Speaker 1:
[09:15] Love it. I definitely agree with that. Greg, thanks so much for taking time with us.

Speaker 2:
[09:18] Thank you.

Speaker 1:
[09:19] That does it for this week's episode of The Markets. I'm Chris Hussey. Thanks for listening.

Speaker 3:
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