MIDYEAR OUTLOOK What History Says Could Come Next By Will Nasgovitz HEARTLAND ADVISORS One of the prevailing nar-Small Cap to Large Cap Historical P/E Ratio (x100) ratives in the market is that after a volatile stretch in which the S&P 500 lost more than 20% of its value in the first half of this year, investors are at their wit’s end. Yet it could just as eas-ily be said that the recent rocki-ness in stocks, brought about by growing fears over rising rates and inflation, is actually the start of rational thinking returning to the markets. Heading into 2022, equi-ties—fueled by more than a decade of record-low interest Source: ©2022 The Leuthold Group, 1/1/1983 to 5/31/2022. The Leuthold 3000 Universe is defined as the largest 3,000 securities traded on U.S. rates—were engulfed in a spec-exchanges. Universe was segregated into large-and small-cap tiers. Blue bars identify recessionary periods of July 1990 to March 1991, March 2001 to November 2001, and December 2007 to June 2009. Price/Earnings Ratio (P/E). Past performance does not guarantee future results. There is no ulative frenzy rivaling some of guarantee that a particular investment strategy will be successful. the biggest manias in history, including the dotcom bubble of the late 1990s and the Nifty and dotcom bubbles burst, investors’ respect for valuations 50 era of the late 1960s and early 1970s. To be sure, some in the subsequent years put the market’s attention back on investors may regard such comparisons to be somewhat of a attractively priced shares of small-and mid-sized companies stretch. But consider the fact that at the peak of the dotcom that were overlooked during the prior manias. In the three bubble in the late 1990s, the total value of companies trading years following the end of the dotcom bear market in 2002, at a price-to-sales ratio of greater than 20 hit a record high the Russell 2000 Index of small stocks gained around 100%, of $3.6 trillion. That record was shattered last year when the outpacing the S&P 500 by more than 40 percentage points. total market capitalization of stocks trading at more than 20 Today, smaller stocks again find themselves trading at 20%-times sales climbed above $5 trillion. plus discounts to large-cap stocks based on their price/earn-And just as the dotcom era was marked by irrational ings ratios, marking only the fourth time in history that small exuberance over profitless companies, the percentage of ini-stocks have been this attractively priced relative to large caps. tial public offerings involving profitless companies recently We believe we are in the early innings of this reawakening, matched the all-time high set in the late 1990s. That’s not even which should start driving investors back to the fundamen-counting the rampant speculation on the 600 or so new special tals—and eventually back to attractively priced small caps. S purpose acquisition companies (SPACs) on the market that are raising funds without having to report revenues or earnings. Will Nasgovitz is the CEO of Heartland Advisors and Heartland Funds. After the Federal Reserve was forced to start raising rates to try to cool inflation, which has been running hotter than it Learn more at www.heartlandadvisors.com and LinkedIn. has in four decades, investors’ appetite for risk-taking seemed See disclosures here. to give way to a greater appreciation for risk and fundamental considerations such as the price you pay for sales and earnings. While it is impossible to predict how much longer this vol-atility will be with us, history does offer some clues on what to expect after such transitions take place. After the Nifty 50 WealthManagement.com • August 2022 • 69