Going against the grain

Buy when there’s blood in the streets is an apocryphal saying attributed to the banker Nathan Mayer Rothschild. It’s also one that investors love to bandy about as a way of showing they know what they’re talking about.

Like most instances of theory colliding with reality, the trouble is that, quite apart from the insensitivity of using a flippant phrase to describe a profitable strategy when there actually is blood in the streets, buying usually seems like a really bad idea. And a lot of the time buying would be the wrong move to make. Investing in tech shares as the Dot Com bubble was bursting, for example, may have been a contrarian move but you’d also have been very likely to end up losing money.

This isn’t to say that Nathan Rothschild was totally wrong. Standing against the crowd and figuring out where to find opportunities in markets when valuations are plummeting is just much harder than a pithy aphorism makes it sound.

The last few months, filled as they have been with political turmoil and spiraling inflation, have provided a simple illustration of this. Aside from buying gold bars and hiding them under your bed, it doesn’t feel like there are lots of attractive investment opportunities on the market.

That’s not necessarily the case though. Panic-driven sell-offs can mark the end of a bubble. It seems clear that many of the firms that went public last year at massive valuations are going to seriously struggle to hit their IPO valuations again, let alone surpass them. But other sell-offs we’ve seen so far this year haven’t necessarily been tied to fundamentals and that is arguably where opportunity lies.

Small cap investment trusts have been hit particularly hard in this regard. There is some logic to this given that lots of small-cap investors focus on growth stocks that trade at higher valuations. A rise in interest rates, and any resulting increase in the cost of capital, would mean you’d expect to see these valuations drop.

However, higher valuations are typically driven by prospective earnings growth. If increases in sales and profit numbers continue to be impressive then any drastic, interest rate-driven falls in share price can seem excessive.

Watches of Switzerland, for example, has seen its share price almost halve in value so far this year. This is despite the fact the company saw sales rise by almost 30% last quarter and it released a trading update recently saying earnings growth was in line with expectations this quarter.

The watch seller is one of several firms in the BlackRock Smaller Companies (BRSC) portfolio to have seen substantial falls in their share price, despite delivering robust earnings growth. Compounding those falls, the trust has also seen its discount widen to 15%.

It’s a similar story with JPMorgan Japan Small Cap Growth & Income (JSGI). The trust has had a tough time in the past few months. As we wrote last week, that’s partly because of falls in the Yen relative to sterling. Still, many businesses in the portfolio, like electronics company Taiyo Yuden, have performed well in terms of sales numbers but have seen their share prices fall anyway.

Both JSGI and BRSC, along with lots of other growth-oriented trusts, may continue to have a tough time in the near term. The question is whether that’s warranted given the performance of the companies in their underlying portfolios. Investors will have to make up their own minds in this regard but in the meantime remember that, while things may ultimately improve, they may well get worse before they do.

Past performance is not a reliable indicator of future results

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