The Rude Awakening
Wall Street, New York
Friday, January 27, 2006 ------------------------- - The crushing effects interest rate hikes can have on
the small guys,
- Know when to ride the highs and when to weather the
lows and,
- No more Maria Sharapova in the Australian
Open…television just got a lot more boring again
------------------------- Joel Bowman, reporting from a not-so-balmy
Baltimore… They came from far and wide for yesterday's monthly
editorial meeting. Mark Bail, the options player of MST
Trader fame, Rude favourite, Chris Mayer from Capital &
Crisis, Addison Wiggin and our own Eric Fry were among
those seated at the table. These meetings always yield
constructive discussion and interesting financial
insight…and yesterday was no different. By far the best idea at the table came from small-cap guru,
James Boric. You probably already know the bloke from his
roll in Penny Stock Fortunes and The Sleuth, a newsletter
dedicated to investment know-how in the small-cap universe.
As the idea is in the incubation stages, I can't tell you
too much about it right now…only that it will change the
way you look at tiny companies and their massive profit
potential. There will be more on this in a short while. For now, I thought it would be good to become a little
better acquainted with Mr. Boric, so please, read on and
enjoy his latest missive below… --- Advertisement --- Earn 4.5 Times as Much Money as Wall Street's Wizards…in
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today… http://www.agora-inc.com/reports/MST/EMSTG136 ------------------------- Grab a Lifeline
by James Boric "Access to capital and cost of capital could be considered
the lifeline to a firm," observes Satya Pradhuman in the
classic book "Small-Cap Dynamics." When capital is
plentiful and cheap, companies tend to thrive. But when
capital becomes scarce, or expensive, companies tend to
struggle…especially small-cap companies. During such
periods, cash-rich companies hold a huge advantage over
their cash-deficient peers. Since interest rates affect the cost of capital more than
any other influence, we small-cap investors cannot afford
to ignore interest rates trends. Historically, the
performance of small-cap stocks has closely tracked the ebb
and flow of interest rates. Between 1969 and 1974, for example, the Fed increased
interest rates from 6% to 12%. The cost of capital (the
cost to borrow money) doubled in five years. As you might
expect, small-cap stocks got crushed. For the entire five-
year period between 1969 and 1974, small-cap stocks lost
4.6% a year and micro-cap stocks fell 10% a year. In 1973
and 1974, the worst two years of the five-year stretch, our
small-cap friends lost 26.5% and another 24.9%,
respectively. Ouch! But if we fast-forward two decades, small cap stocks
enjoyed a much friendlier interest rate environment. The
Fed lowered interest rates from 8.25% in June 1990 to as
low as 3% by the end of 1993. The results were sweet.
Small-cap stocks soared a cool 28.2% a year between 1990-
93, trouncing their large-cap counterparts in the process. As we approached the end of the millennium, small-cap
stocks zoomed once again. Between May 2000 and June 2004,
Alan Greenspan lowered short-term interest rates from 6.5%
to a meager 1%. This loosening of the monetary purse-
strings seemed to supercharge small-cap companies and their
stocks. From the beginning of 2000 to the present, the
small-cap Russell 2000 is up 85%, compared with the S&P
500s rise of only 23%. It has been a very nice ride for us small-cap investors.
Just about everything is up from where it was a few years
ago. Fundamentally sound companies are up. Growth
ccompanies are up. Even companies that lost money and
boasted the ugliest balance sheets you could imagine are
up. But these recent boom years could eventually yield to a
few lean years. A great way to prepare for that possibility
is to focus on companies with cash-rich balance sheets. Here's why: Typically, lenders are much more willing to
dole out the dough to smaller, riskier companies when
interest rates are low. Generally, it is a sign that the
economic forecast is bright and the risk of a smaller
company defaulting on that loan is lessened. Of course,
when rates start to rise and the economic backdrop isn't so
rosy, lenders become tight with their money. They only lend
to the largest of blue chip companies -- the ones with very
low perceived risk and plenty of capital resources. Based on historical trends, short-term interest rates today
are still very low, at just 4.25%. Yet they are rising. And
that is almost never good news for small-cap companies. So
we should be looking at companies that can survive a period
of monetary tightening. We should look to invest in
companies with the resources to grow their businesses even
if (or when) the banks won't lend money on attractive
terms. In other words, we should be seeking out -- now more
than at any point in the last few years -- companies with
stockpiles of cash. Cash provides flexibility. When times get tough (or even
just a bit tougher than they were before), a company with
cash can still manage to broaden its product lines, pay out
dividends, fund R&D projects, buy back its own shares, make
good on any liabilities, take advantage of an attractive
acquisition target or even become a takeover candidate
itself. | 
