Outbreaks and New Rates

In our previous commentary, “War-Torn Week”, we adapted the blues song “Stormy Monday” to describe the tone of the market. We expressed our belief that in the upcoming week that the war would be the primary determinant of the direction of trading, with the FOMC meeting, PPI report, and all things China also having significant influence.

On Monday, the global equity markets extended their losses, as an outbreak of Covid-19 in a major manufacturing city in China led to lockdowns, renewed supply-chain concerns, and highlighted that the battle against the virus was still raging.

A wild rally started Tuesday morning that gathered steam as the week progressed, closing at the high on Friday. The market tallied its best week since November 2020, with the S&P 500 +6.1%, the Nasdaq Composite +8.2%, and the Russell 2000 +5.4%. Essentially every asset class reversed course, with the most speculative stocks surging the most, while the dollar, gold, and oil all declined. On the other hand, the trends of rising interest rates and a flattening yield curve did continue, with the 10-year Treasury rate closing up 15 basis points to 2.15% and the 2-year finishing at 1.98% resulting in a 7 basis points flattening of the curve to just 17 basis points. The 2-year rate is much more sensitive to increases in short-term interest rates, and as expected on Wednesday the Fed did raise its benchmark rate by 25 basis points, its first increase since 2018. Whereas the statement from the FOMC was quite hawkish, with higher inflation expectations, and 6 more hikes planned for 2022, Chairman Powell was able to soothe investors’ concerns over stagflation, citing a very strong economy. Another positive that helped fuel the rally was a denial that China is considering support for Russia and is indeed interested in finding a peaceful solution to the war in Ukraine. There continues to be tension between the U.S. and China, however, as in a meeting with President Biden on Friday, President Xi Jinping suggested that the U.S. was at least partially responsible for the conflict by forcing Putin’s hand.

We felt encouraged by the meetings that we had at the annual ROTH conference with the management teams from 21 small-cap companies. Our key takeaways from those meetings:

  • Supply chain disruptions have not improved and will persist longer than anticipated. Few management teams were willing to predict exactly how much longer because they were surprised these challenges have not been resolved.
  • The companies are seeing higher energy cost inputs and wages across the board and can pass these costs on at about a 3-month lag on average. It has become less of a challenge to get labor and uniformly, no company we spoke with seemed to be concerned about the demand for their products or services.
  • Most of our companies sell domestically, so they have very low or zero exposure to the Russian economy apart from the second derivative effect of higher energy prices. Additionally, these companies have made progress over the last 3 years in redirecting sourcing away from China.
  • Valuations across the board are inexpensive; these companies used the pandemic to become better operators with strong net cash balance sheets and will be able to pass along costs as well as withstand rising interest rates.

On a related note, the North Star Research Team just completed a white paper discussing how small-cap utilities fare well in periods of rising rates and rising energy prices; in fact, the small-cap stocks do much better than large-cap peers during those times. Read it here.

Ruble to Rubble

The economic calendar is relatively light, with durable goods and both services and manufacturing PMI released Thursday. Those reports will take a back seat to developments in the Russian assault on Ukraine. President Biden will travel to Brussels on Thursday to discuss ongoing deterrence and defense efforts in response to Russia’s attack on Ukraine. President Biden will also join a scheduled European Council Summit to discuss the transatlantic efforts to impose economic costs on Russia, provide humanitarian support to those affected by the violence, and address other challenges related to the conflict.  To date, Putin has responded with increasingly violent and desperate measures, while Russia’s military has suffered unexpected losses, the Ruble has turned to rubble, and the Russian economy is on the verge of collapse. Thus far the U.S. equity market has experienced increased volatility but has only had a modest decline since the onset of this crisis.

Stocks on the Move:

+10.8% Amazon.com Inc (AMZN) is an online retailer that offers a wide range of products. The Company products include books, music, computers, electronics, and numerous others. Amazon is also the dominant cloud services provider (through Amazon Web Services, or AWS), an influential entertainment company through its video streaming operations, a force to be reckoned with in grocery with its ownership of Whole Foods, and a leader in digital personal assistant devices (Alexa and Echo). Last week, upon winning approval from Europe and the U.S. FTC Amazon closed the $8.5B deal to purchase MGM Studios including its library of 4,000 film titles and 17,000 TV episodes.

+19.5% Boot Barn Holdings Inc (BOOT) sells western and work gear for individuals and families. The Company sells boots, jeans, shirts, hats, belts, jewelry, and other accessories. Footwear and apparel stocks fared well last week with cooling tensions between the U.S. and China, as well as business-friendly measures taken in China to help sort out the supply chain crisis.

+13.7% Paramount Global (PARA) operates as a multimedia company. The Company provides television and radio stations, produces and syndicates television programs, broadcasting, publishes books, and online content, as well as provides outdoor advertising. PARA was a top gainer in the Communications Services sector last week.

+11.8% Sono Group N.V. (SEV) manufactures and sells electric cars with integrated solar cells and panels. In addition, the Company monetizes its variable battery technology for integration in numerous types of vehicles, including buses, trucks, camper vans, trains, and boats, as it aims to reduce carbon emissions and provide clean and affordable transportation for the masses. Last week, Sono announced the reveal for the Sion’s final design will take place in summer of 2022 with the company aiming to deliver vehicles in the mass market in the next year.

+12.1% Value Line Inc (VALU) produces investment related periodical publications. The Company also provides investment advisory services to mutual funds, institutions, and individual clients. All total, Value Line collects data and provides analysis on around 7,000 stocks, 18,000 mutual fund and 200,000 options. The VALU Board of Directors renewed a $2M share repurchase program last week.

+16.6% Build-A-Bear Workshop Inc (BBW) is an interactive and entertainment mall-based retailer that invites guests of all ages to create their own customized stuffed animals with clothing, shoes, and accessories through a bear-making process. BBW jumped last week after increased buying from Cannell Capital.

+19.3% Century Casinos Inc (CNTY) operates as an entertainment company. The Company owns casinos, hotels, and luxury cruise vessels. Travel and leisure stocks saw gains last week due to anticipation of a incoming heavy spending during the summer months.

+10.8% Escalade Inc (ESCA) manufactures and sells specialty sporting goods. The Company is the world’s largest producer of tables for table tennis under the Ping-Pong and STIGA brands; its other products include hockey and soccer tables, play systems, archery, darts, soccer nets, and fitness equipment. There was no significant company news last week.

+19.3% Flexsteel Industries Inc (FLXS) manufactures and sells wooden and upholstered furniture for the retail, contract, and recreational vehicle (RV) furniture markets. The Company’s products are sold to furniture dealers, department stores, and RV manufacturers. There was no significant company news last week.

-11.7% LSI Industries Inc (LYTS) designs, manufactures, and markets a variety of lighting fixtures, menu board systems, and graphic products. The Company sells its products to the petroleum and convenience store market, the multi-site retail market such as restaurants and automobile dealerships, and the commercial and industrial lighting market. There was no significant company news last week.

+10.1% Napco Security Technologies Inc (NSSC) manufactures electronic security devices, fire detection products, access control systems, and digital lock equipment used in residential, commercial, institutional, and industrial installations. There was no significant company news last week.

The stocks mentioned above may be holdings in our mutual funds. For more information, please visit www.nsinvestfunds.com.

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