3 in 3: Small Caps Big Spenders, Cyber Splurge, a Chemical Romance

Small cap companies are spending more and that's a good thing. Cybersecurity stocks are going down, but demand's going boring specialty chemical companies are starting to get a little less boring. I'm Jim Lydotes, and these are three ideas in three minutes. So let's flip over the timer and let's go. 

So first, small cap spending. Companies spend when they feel good about the outlook. One of the things that we closely track is changes in spending expectations as earnings come through. Compared to just two months ago, spending expectations are much higher. But what matters most is how broad those spending expectation changes are. They're broad across sectors, they're broad across cap, But what's most interesting to me is that the rate of change in small caps is 2x as large as what we're seeing in large caps. So despite higher input costs and greater geopolitical uncertainty, companies that are closest to the data are not pulling back. In fact, they're accelerating their spending. Small caps are cheap just as earnings season is delivering a pretty meaningful vote of confidence that conditions are improving. 

Second, cyber spending is holding strong. Cybersecurity stocks have been hit pretty hard. ETFs that track the space are down about 10 % this year. They're down about 20 % over the last year. So it's been a pretty challenging space. But our proprietary Grassroots Research tells quite a different story. After interviewing expert buyers, we didn't hear a single respondent expecting to spend less over the next 12 months. And about three quarters of respondents expected to spend more. That's one of the most bullish signals that we've seen across all of software. And it's completely disconnected from how the stocks are trading. That gap is creating what I think to be a pretty meaningful opportunity in the cyberspace. 

And finally, specialty chemicals. specialty chemicals, which are chemicals designed for a specific purpose, are boring. They're cyclically cheap. Sentiment is awful. And nobody wants to talk about them right now, which I think is creating a pretty interesting setup. What people are missing is that while we are spending hundreds of billions of dollars building out AI data centers and semiconductor fabs in the US, people are not paying enough attention to where some of these critical chemical inputs come from. In addition, China has quietly built significant supply in many of these critical materials, and that's a vulnerability that right now isn't priced into equity markets. So today, if you buy specialty chemical companies with the right semiconductor exposure, you're getting trough valuations with essentially two free embedded call options. So the first is housing. Housing activity right now is frozen. Permits are down over 7% year on year, but a single new home contains over 6,000 pounds of new chemical inputs. So when rates come down enough to unlock even a modest recovery, the pull through into the specialty chemical space could be fast. So you don't need a boom, you just need bad to get a little less bad. The second option is any disruption to Chinese supply, which would reprice these stocks almost overnight. So you don't need both, just one, and you have a cheap sector with a couple of embedded call options. 

That's our three points and three minutes with a little sand left in the bottle. Have a great week and we'll see you here next time.