Jefferies taps small- and mid-cap stocks that rank well on all factors

Jefferies tapped nine themes and then ran a quant screen on factors that fit their strategy best.

It came up with 19 names, but with a twist.

“We decided to use our quant model and factors to determine our themes and in the end, we came away with 19 Buy rated ideas,” Strategist Steven DeSanctis wrote. “The one twist on our screen is that we eliminated both the most expensive and the cheapest names, and focused in the middle of the pack. We like the fact that we have stocks from 8 sectors represented.”

The nine themes are:

1. Nothing is going right for small caps these days, just one piece of good news could turn tide – “It has been one of the biggest turnarounds for small caps that we can ever remember, The Russell 2000 (IWM) went from being 473bps ahead of the S&P 500 (SP500) (SPY) (IVV) (VOO) to now behind by over 8% and the difference is even worse vs. the QQQ (QQQ).” But “A number of the macro factors we track have shown signs of improvement. Both equity and bond market volatility has fallen from their peak levels, and high-yield spreads have narrowed.”
2. Cyclicals are performing like they are in recession, trading below prior economic slowdowns on P/E – “With the ‘R’ word being used more and more these days and the volatility around the Regional Banks, investors have really soured on the Cyclicals these days. We think a lot of bad news has been priced into this cohort, similar to that of small caps, and if anything goes well, we should see this group rebound.”
3. Value beats Growth: Same pandemic playbook for style as Cyclicals, which we disagree with – “It has been an even tougher road for Value (IWD) vs. Growth (IWF) these days, as the style index has been saddled by weaker performance from Financials (XLF), Energy (XLE), and Real Estate (XLRE) while Growth gets a boost from Tech (XLK) (XLC) and Health Care (XLV). History may not repeat, but it does start to rhyme and this is starting to remind us of ’00-01.”
4. Our two new themes have started to work, more to go – “Two of our recent themes, better balance sheets and cheap stocks lagging, have been working and should continue.”
5. Foreign ahead of Domestic; this should continue – “The gap in performance between names with significant overseas exposure and those that do not has been significant at 540bps thus far this year and running close to the entire difference we saw in ’16. Although we think this is where most investors have positioned themselves, and we tend to act against the grain, we still think this theme has legs.”
6. Smaller is better? Has been the case recently but flows have yet to kick in – “We have seen a very strong bounce by the smallest of the small, despite not much interest in the size segment from ETF flows. This is the cheapest part of the market and has started to see M&A pick up, however, we still find it odd that these stocks have rebounded recently.”
7. Higher quality makes sense, but has not worked over last three months – “Over the last two months, we have seen a rebound by the lowest ROE, nonearners, as well as no sales companies, and we find this very odd. Given the pullback by small caps, one would have thought these stocks would be lagging, which again is not the case.”
8. M&A activity has picked up, the market dislocation will create better backdrop for deal activity – “Even though it may not feel like deal activity is picking up, it certainly has across the small caps. The 42 deals announced through the end of April puts the full year on pace for 126 transactions, both above ’22’s levels and the long term average. An acceleration in deal activity boosts the case for small caps.”
9. “The Golden Age of Active Management” has taken a pause of late – “Given lower cap and lower quality outperforming recently, it has really hurt active manager performance, especially for Growth. The last several months have pushed alpha further into the red for the category over the last 12 months. However, we still think we could be in ‘The Golden Age for Active Management.'”

The screen:

1. Ulta Beauty (NASDAQ:ULTA), quintile ranking where lower is better on quality 1, momentum 1, balance sheet 1
2. Civitas Resources (NYSE:CIVI), 2, 3, 2
3. Denbury (DEN), 2, 2, 2
4. Interactive Brokers (IBKR), 2, 1, 1
5. Discover Financial Services (DFS), 1, 3, 3
6. Ameriprise Financials (AMP), 1, 3, 1
7. agilon health (AGL), 1, 2, 1
8. Hims & Hers Health (HIMS), 1, 1, 1
9. Copart (CPRT), 1, 2, 1,
10. Paycom (PAYC), 1, 2, 1
11. Graco (GGG), 2, 1, 1
12. Textron (TXT), 2, 3, 2
13. Terex (TEX), 3, 1, 3
14. Keysight Technologies (KEYS), 2, 1, 2
15. Allegro MicroSystems (ALGM), 3, 1, 1
16. Onto Innovation (ONTO), 3, 1, 1
17. FMC (FMC), 3, 3, 3
18. Summit Materials (SUM), 3, 2, 2
19. Zillow (Z), 2, 2, 2

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