Portfolio Manager Perspectives

Jeff Benjamin

Small-cap value ready to soar, says Elessar Investment's Giesen

The chief investment officer is experiencing déjà vu with small-caps' leading the rally

Jan 6, 2010 @ 4:43 pm

By Jeff Benjamin

The outlook is bright for small-cap-value stocks during this “late phase of the market expansion,” according to Rick Giesen, chief investment officer at Elessar Investment Management LLC.

Mr. Giesen, a bottom-up stock picker, compared the current market and economic cycle to the periods from 1990 to 1992 and 2002 to 2004. Both periods saw interest rates drop, unemployment climb and wild stock market swings.

In the 1990-92 period, for example, the Federal Reserve cut interest rates to 3%, from 9%, unemployment climbed to 8%, from 5%, and the S&P 500 was down 3% in 1990, up 31% in 1991 and up 7% in 1992.

In the 2002-04 period, interest rates hit a low point in 2003, unemployment gained 3 percentage points to hit 7%, and the S&P 500 lost 22% in 2002, gained 29% in 2003 and increased 5% in 2004.

Mr. Giesen sees a similar pattern unfolding this time around. And like past cycles, he expects small-cap-value stocks to lead the way.

In both 1992 and 2004, the years in previous cycles comparable to 2010, such stocks outperformed all other categories.

In 1992, the Russell 2000 Value Index gained 29%, while the next-best index, the Russell 2000 Index, gained 18%.

In 2004, small-cap value gained 22%, ahead of a 20% increase by the MSCI EAFE Index, the second-best-performing index.

“We're not market timers or technicians, and we're not prognosticators, but it seems like this series of events and conditions is exactly what happened before,” he said.

As a manager of separate-account portfolios, Mr. Giesen is looking for solid fundamentals in high-quality companies.

“The earlier phase of this market, involving the high-beta-risk trade, has run its course,” he said. “This new phase will be about valuation and alpha.”

While fundamentals have been slim lately, Mr. Giesen does like a couple of companies that are benefitting from increased demand for electronics in Asia.

The demand is fueling capital spending in the semiconductor space, which will benefit select companies, including Verigy Ltd. (VRGY) and Entegris Inc. (ENTG).

“We don't make sector bets,” he said. “The fundamentals have to be strong, and there has to be a catalyst that we can identify.”

Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives .

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