Stocks That Soared The Last Time Markets Were This Wobbly

The article advises investors to disregard market 'noise' and focus on fundamental data, which indicates the broader market is nearing extreme valuations while presenting significant bargain opportunities in overlooked small-cap deep-value stocks. Drawing a parallel to the period preceding the dot-com bubble, it suggests these assets are poised for a potential long-term rally after extended underperformance due to passive investing. NACCO Industries (NC) is highlighted as a prime example, being profitable, trading at 67% of tangible book value with low debt, growing earnings and cash flow, and diversifying operations in coal, oil/gas royalties, and lithium, positioning it for potential M&A and benefiting from increasing energy demand, including from AI.

Analysis

The current market environment is characterized by a divergence between widespread media noise and underlying financial data. Key indicators such as the CAPE Ratio, aggregate Investor Allocation to Equities, and Market Cap to Gross Domestic Product suggest the broader market is approaching extreme valuation levels. Despite this, complacency appears prevalent as High Yield Credit Spreads and the VIX show no signs of investor fear. Technical signals provide a note of caution, as the number of stocks trading above their 5- and 20-day moving averages has been in sharp decline for two weeks from high levels. This macro context highlights a significant dislocation and potential opportunity in small-cap deep-value stocks, which have underperformed growth for an extended period, drawing a parallel to the environment preceding the post-dot-com bubble rally in small-caps. The recommended strategy is to filter this segment for profitable companies with low debt and strong cash flow. NACCO Industries (NC) is presented as a prime example, a profitable coal and energy royalty firm trading at just 67% of tangible book value with minimal debt. The company is growing earnings, increased its dividend by 11% in May, and has exposure to lithium mining, positioning it not only as a value play but also as a potential beneficiary of M&A and increased energy demand from sectors like AI.

Key Decisions for Investors

• Exercise caution with broad market equity exposure, particularly in large-cap technology, given that multiple indicators point to extreme valuations and weakening market breadth.
• Consider reallocating capital to the small-cap deep-value sector, which shows signs of being historically undervalued and primed for a potential long-term rebound relative to growth stocks.
• Implement a disciplined screening process for small-cap investments, prioritizing companies with consistent profitability, low debt-to-equity ratios, and strong operating cash flow, while avoiding speculative story-driven firms.
• NACCO Industries (NC) warrants further due diligence as a potential long position, given its deep value metrics, strong balance sheet, dividend growth, and diversified commodity exposure that could benefit from increased M&A activity and energy demand.