Value Options: Small Caps vs. AI Giants: Is This a Historic Value Opportunity?
Sunday, October 4, 2026 · Johnny Hopkins
During their recent episode of the Acquirers Podcast, Travis and Carlisle discussed:
- Rising Treasury Yields: Why Higher Interest Rates Pressure Stocks
- Oil Prices and Inflation: Why Diesel Costs Still Matter
- Housing Market Freeze: Are Homebuilder Stocks Offering Value?
- Small-Cap and Mid-Cap Stocks: A Historic Value Opportunity?
- AI Spending Risks: Can OpenAI Justify Its Huge Funding Needs?
TRANSCRIPT
[Tobias] This is the Value Options Letter podcast. I’m Tobias Carlisle, joined as always by Tim Travis. How are you, Tim? [Tim] I’m doing all right. Toby, how about you? [Tobias] Not my favourite month in the market. We’re recording this 30 September, so one of the worst relative performances I can remember in a really long time. So I’m looking forward to doing a little therapy session with you. [Tim] Let’s do it. I think that feeling is felt with most active managers. It’s a very, very interesting dynamic.The market breadth has just been atrocious.
Rising Treasury Yields: Why Higher Interest Rates Pressure Stocks
[Tobias] Yeah, I’m not sure what the reason is. I think one of the things that I think it’s probably caused by has been this massive ramp in the yield. So I track the 10-year yield because I think that that’s a proxy for stocks.I don’t know whether it’s the really long data. I don’t know if anybody’s ever looking at the 30-year when they’re thinking about stocks, but I think the 10-year is a pretty good proxy. It’s gone through.
It was 5.26 yesterday at the close. I think it’s like 5.4 or something now. The yield is really ramping up.
The long run average is about 6%, I think. So I actually looked up a chart. I found one on the multiple.com website that goes back 150 years. And I looked at it in terms of how often has it been higher than this level. And so we have to go all the way back to April 2002 to see a 5.2 handle. We got close, I think, through 2007, but I think it topped out at about 5.1. So you’ve got to go back a long way. That’s 24 and a half years, almost 25 years since we’ve seen rates this high. And then we’ve only been higher than this through the 60s to the 90s, which is about 35 years out of that 150. So I think these are fairly unusual circumstances.
And probably the rate at which has gone up is even more unusual. And I think that that is what is impacting stocks. I know that Buffett has said that rates act like gravity on equity prices, which makes total sense to me that if you’ve got an alternative that’s risk-free, as risk-free as you can get versus something that’s whipping around like equity, then you might prefer to just take that risk-free 5.4 or whatever you can get in the market. But then there’s also this other study that I’ve seen on the equity risk premium. John Hussman has this great long-term study where he looked at how predictive is the equity risk premium. So the equity risk premium is the size of the yield, the size of the equity pre-E yield, so the E on the P rather than the P on the E, versus the yield on the 10-year.
And he’s basically found that there’s no connection between them whatsoever. And it’s really just the absolute level of equities that dictates the returns, which is totally unexpected to me. I don’t know why that result is, but that’s what the data shows.
So I’m sort of inclined to believe that, even though I can see how behaviour would be impacted by the level of rates. So I don’t know then, the next question is sort of what’s driving rates, but let me get your take on rates first.
[Tim] So there’s the macro people that are saying something that’s like the yen trade unwinding. That’s above my pay grade, honestly. I’m not an expert on foreign currencies.But you have this never-ending conflict with Iran. And the main issue is it’s interesting because they’ve actually found a route along the coast of Oman where they’re actually able to get almost as much crude as they were exporting before the war through the Strait of Hormuz now, from my understanding. So it’s more costly to do it that way, of course, because they have to have these flotillas and everything.
But diesel prices and aircraft fuel are just sky high. And those are tougher to slow down because they’re used on trains, they’re used in farming, they’re used in trucking. And so that’s really driving inflation.
And then some people think inflation begets more inflation. I mean, everyone has to increase prices accordingly and higher interest rates to account for that. So definitely a lot of negatives on that front.
But what’s interesting is this. If you told me that the markets as a whole were declining significantly due to interest rates, like Buffett says, that would make logical sense. But what’s funny is that the indices haven’t budged that much.
They’re still pretty close to their highs. But the internal breadth of the market, there’s huge, huge percentages that are down 10, 20, 30 percent. And a lot of that is this month.
I had a statistic where the equal, I think this was like the sixth most extreme difference between the S&P 500 and the equal weight S&P. And you look at what’s driving the market year to date, and it’s all AI-related stocks. It’s really incredible.
I mean, if you’re looking at it’s NVIDIA, Apple, Alphabet, Broadcom, Amazon, Intel, Micron. I mean, Micron started the year a very small percentage of the index, but it still is driving it. And then you’ve got your Exxon, Caterpillar, which is basically AI with the generators, and then SanDisk.
So that’s not most of the general economy. That’s the AI economy.
Oil Prices and Inflation: Why Diesel Costs Still Matter
[Tobias] Yeah. A little bit to unpack there. Let’s go first to oil because I’ve noticed that when we post these videos that folks are very interested in oil.So let’s talk about oil for a little bit. Oil prices on a real basis are nowhere near previous peak. So I think that the 80s peak in real terms is something like $230, which is just unimaginable at the moment.
This is on WTI. And we saw like $100 WTI. And I think, well, I saw yesterday it’s fallen to $90.
I’m guessing because there’s a little bit of oil coming through the straight. And oil equities haven’t really at any point responded to the oil price, even though I think that they’re much better managed now than they have been in the past. I just think they’ve been so starved for capital for so long that they’ve had to adapt, and that’s made them better managers.
Also, there’s the shale in the US means that there’s a little bit of a cap on prices. And it’s also that the economy is much less oil intensive energy. It’s energy intensive.
It’s much less oil intensive than it used to be. And I guess that that’s a trend that just continues on. I don’t know if that’s EVs driving or we’re just finding substitutes or what is causing that.
Or maybe it’s just that the efficiency of business, most of it being done online, means that oil is just not as impactful as it used to be. But the thing that really is interesting is the diesel and the oil prices at the pump seem to be extremely high so that the distillers are doing very well, and the cracks are very wide. Diesel, I think I said this a few weeks ago, but they’ve only got figures for three figures on the price charts here.
It only goes to $9.99. You can’t go over that. They’re accommodating these new numbers, which is a scary thought. So it’s not quite the handbrake, it seems, on the economy that it used to be.
Do you think that’s fair?
[Tim] I would agree that it’s not what it used to be. But you tack on this. I mean, if you look at the housing economy, the real estate economy right now, I mean, that’s serious pressure.I mean, you already had so many people that are kind of sitting in homes that they probably would like to sell, but they don’t want to give up their mortgage. You had a bunch of people buying houses, and that were basically told, hey, do an adjustable rate, and then you’re going to refly out of this, or do interest-only even. Rates are going to go down.
The Fed was prognosticating that rates were going to go down, and they’ve gone up. So it’s going to slow down a huge part of the economy there. I mean, if you look at almost all of the capital investment, almost all of the property-related investments, whether it’s apartment buildings or housing or whatever, most of those are down.
It’s just all in the data centres. So it’s a data centre-driven economy. The markets held up okay on employment.
It’s pretty low. Businesses are doing all right. I mean, even like home builders, they’re still making money.
I mean, they’re not losing money. It’s nothing like, of course, nothing close to 2008 or a real recessionary environment. But the market doesn’t tell the story of the underlying economy, in my opinion.
[Tobias] Real estate’s an interesting one, because there’s been some debate about whether it is, in fact, being driven by rates. I mean, that’s the question. Is it mortgage rates, which are pretty high?We’re back to sort of the peak was like 23, 24, the recent peak, and then we have to go back a little way to see higher rates again. But we’re sort of pushing up now towards that. It’s like 7.5% to 8%, which is a pretty hefty mortgage. And then that Nick Gurley looks at real property prices versus rates. And his view was that real property prices are like 40% over their long run means. And it’s really that that is driving.
And you can see that the charts for mortgage origination are like absolute rock bottom. They’re lower than they were through 2006, 7, 8, which is like the trough of the last great recession. And that’s kind of amazing.
You have to go back 30 years to see these kind of levels. And the population of the US is so much bigger than it was then that really it’s this complete nuclear winter for real estate. And I don’t know what turns that around.
I guess you got to see lower prices, but there’s so much friction in that market because you see folks with 3% mortgages. Sort of in California, particularly, there’s more folks with 3% mortgages than there are with 6% mortgages. And I think that when those two cross over, that threshold sort of means maybe you get a little bit of an unthawing in the market, but we just haven’t seen that yet.
So folks are kind of stuck in their houses. It’s funny to see in that context with that background, Buffett has moved to buy a big chunk of Lennar or that’s a home builder. And I think the home builders have looked like reasonable value here and there over the last few years.
Have you looked at any home builders?
Housing Market Freeze: Are Homebuilder Stocks Offering Value?
[Tim] Well, yeah. I mean, they bought Taylor Morrison. They bought the whole company.So they’re going big in that space. And so I think if you look at the value proposition there, it’s attractive. Some of those companies are trading at discounts to book, Meritage Homes, Lennar.
We’ve had a few trades on them on the value options letter that have been very successful and where it’s attractive because you’re able to kind of manufacture that entry price into it. So you can get in at lower prices than Buffett was buying stock in, I guess Berkshire was buying stock. You don’t know for sure if it’s Buffett anymore.
So, but yeah, I think that’s an interesting space. The thing with higher rates is they’re definitely negatives for real estate in general, but long-term they create the environment for a better environment in the future because apartments aren’t getting built right now. They’re not building medical labs.
They’re not building many hotels and stuff like that. I mean, and that’s been going on for a few years, really since the interest rate cycle started and got serious. And so there’s going to be a point where there’s too little supply to meet demand and things like rental prices are going to go up a lot.
I mean, it’s still way cheaper to rent than it is to buy a home, even though it’s not the best housing environment for like the home builders. But like renting is a pretty good deal. I mean, I know it’s still expensive, but it’s a pretty good deal relatively.
So it will set the stage. How long rates stay up here? That’s really the million dollar question.
I mean, I feel like the economy is going to start feeling the pressure a lot more.
[Tobias] Well, it’s been tough, I think, because inflation expectations or inflation, the Fed has this target of 2%. I don’t really understand why 2% is a good number. I’ve never seen any justification for why it wouldn’t be 0%.I would have thought that no inflation would have been a good thing. 2% just means that your money loses its value in like reasonably quick, but 2% is the target, but they’ve now spent more than five years over 2%. We’re like three and a bit percent at the moment.
So I think they’re really caught between a rock and a hard place because they’ve got on one hand, mortgages are stuck, people sort of want, and it impacts small businesses and it impacts small and mid-sized businesses, which are the businesses that I tend to traffic in. I can see that running through all of their financial statements. It really does impact them more than the bigger companies because they can’t turn out their debt as well.
They sort of catch those rates just as they change. But then on the other hand, if they put rates up and they’ve got, the federal government’s $40 trillion in debt, it’s got $2 trillion in interest. The Fed’s supposed to be independent.
It’s not supposed to sort of look at those things, but I can’t imagine that you can’t take down the federal government because you think that rate should be a little bit higher. Yeah.
[Tim] No, no. I mean, I feel like the short-term rates, there’s not that much flexibility there. I think that if they didn’t hike in the last meeting, you’d see long-term rates probably go up even more.I mean, you got to just look at what the drivers are of inflation and energy prices are a big component of that right now. And they’re making some progress in that they’ve found kind of a workaround with Iran, but Ukraine damaged a few of the Russian refineries and Russia’s basically not exporting diesel. China’s not exporting diesel.
Our refineries really aren’t made for that. They’re not geared towards that as much. So it’s just not as easy to fix that as it is to fix crude.
And we do have the ability to pump more and stuff like that. So it’s a challenging one, Toby. It’s just a very interesting dynamic where the indices themselves are so bifurcated from what you’re seeing in just the general market.
I mean, you have stocks like McDonald’s, Pepsi, Clorox. Consumer staples have gotten crushed. Real estate’s gotten crushed.
Asset managers have gotten crushed. A lot of insurance companies are trading really cheaply. Like Assured Guarantee, the municipal bond insurer, from a percentage of their adjusted value, it’s trading at one of the cheapest levels I’ve ever seen.
The only real exception would be like the financial crisis kind of era. And the fundamentals are really good, like really strong. And one of the biggest credits that they were worried about, they just had a restructuring and I don’t think they’ll lose any money on that restructuring.
So it’s interesting, though, even like AIG, a lot of these are just seeing pressure. So it’s tough to put your finger on it. It’s definitely one of those months that you’re going to remember.
It’s one of those months where things just don’t seem like they’re operating well. I don’t know who you use, but I use Think Pipes as my platform with Schwab. And I have a list of probably 150 stocks on there.
And it is red almost every day, Toby. And it’s like, OK, well, what’s up? And it’ll be, oh, Nvidia’s up two bucks, you know, and SanDisk and Micron.
But Meta’s had a great run and we’ve had multiple trades on the website on Meta. Meta was trading very inexpensively. They’ve hit a home run with Muse.
I mean, it’s a total. What’s so good about it is that it’s got like the ease of use elements of like a clod. But it’s got the distribution of Facebook.
So, you know, anyone with a Facebook account or an Instagram account that maybe was a little resistant to, you know, get much involved with AI, it’s putting it in front of them. And it’s easy. You already have these products.
So, you know, why not use it over some of its peers? I mean, it’s really fascinating. I mean, I give a lot of Zuckerberg, man, he’s got balls and he’s made some good moves, that’s for sure.
[Tobias] The thing about Zuck is it’s funny how he must have the shortest distance between goat and like, you know, idiot. I mean, this is the market, you know, reviewing him. He goes from like being an AI loser to an AI winner.The market is just completely insane when it comes to assessing the performance of Meta. It’s crazy. Creates opportunity, but it’s wild volatility.
Small-Cap and Mid-Cap Stocks: A Historic Value Opportunity?
It’s one of the things that I, you know, aside from the fact that I run a small and micro portfolio and a mid cap portfolio and I sort of focus on industrials and I look for things that are going to get taken out and I’ve never seen this sort of level of quality come into the like takeout range in the time that I’ve been running it. It may be like 2020 at the bottom, which seems crazy because the market is so expensive. Like on one hand, you’ve got the market trading at like a 41 pie CAPE, which is, you know, people get upset about CAPE, but it rhymes with every other like market level measure like Tobin’s Q and Buffett’s measure of GNP, total market capitalisation, or just the trend above the long run trend.
I don’t know whether those metrics work in the, you know, now that we’re all living in this post-singularity world, but they have been pretty predictive in the past at an index level for the S&P 500, but the S&P 500 relative to mid caps, mid caps are absolutely trough. They’re back to like 2002. Small caps are the same, like back to 2000, 2002 levels on a relative basis.
Just on a performance. This is on a performance basis. And then it’s like, you can look at RSP, you can look at equal weight SPY versus the regular S&P 500 that everybody knows, which is market cap weighted, float adjusted, which benefits the biggest stocks over the smallest stocks.
Similarly, that’s back to like a 2000, 2002 level. And that peaked around 2015. So it’s been going backwards for like 11 years, which is kind of amazing because over the long run, because small caps tend to grow earnings faster, small caps tend to outperform.
And there’s a great, the CFA society released it’s, they used to call it like triumph of the optimist, but it’s the, it’s got a different name now, but it’s like this, it’s this incredible document. It’s like a hundred plus pages, 200 plus pages of all of these charts of all of the financial market data history that we have going back across lots of different countries as well. And so you can look at the performance of small caps, like small caps of wildly outperformed large caps over that period of time, except for like this.
And there are these various periods of time where it doesn’t outperform and that’s usually around these stock market booms. So 2000 was the last one. There was a sort of a minor blip in 2007, six, seven, that kind of period of time.
And now we’re in this like towering outperformance for the big stocks over the small stocks. And so I imagine at some point this sort of reverses and it goes back to that very long run mean of these small companies tending to outperform, or maybe not, maybe we’ve like changed the complete, completely changed the structure of that market so that, you know, Sarbanes-Oxley came in in 2000. And this is one of the charts that they tracked as well, as they show the number of stocks that are listed.
And so the number of stocks that are listed are down like by 40% since the peak, which was around 2000. And before then it had grown, you know, pretty consistently for like the hundred years before then. So not only is it down 40%, like relative to where it could be if those companies had listed, like it might be a third of where it could have been.
It might be less, it might be even less than where it could have been. And it means that like they can’t even fill out the 5,000 because there aren’t 5,000 stocks for that. Like it’s tough to find enough listed stocks.
And so maybe that’s had this impact on the market. Maybe it’s that, you know, Facebook didn’t go public until it was already a large cap. That tends to be SpaceX goes public as a large cap.
It’s likely that Anthropic and OpenAI go public as large caps. So they just don’t get that, you know, where back in the seventies, Walmart goes public as a small cap. And so you could have bought it then and enjoyed it as a public market investor and seen all of those returns.
So it’s possible. And you have to consider the possibility because it’s like such a wild divergence in that market from where it has been historically, or it’s one of the all-time great opportunities to be a small mid-cap investor. And I don’t know what the correct answer is, but I think that smaller mid-cap, to me, they look, when I go through, I think the quality has never been higher for the prices.
And I wouldn’t be surprised to see a big uptick in private equity. Although private equity has got its own problems too, because they seem to be packed to the gills.
[Tim] Yeah. It’s the interest rates are so high. So, but there still is like a lot of cash in there.Yeah. I mean, I agree like valuations on a lot of stocks. I mean, you look at like an ally financial, it’s trading at a significant discount to book value and the actual earnings and the margins have been really good and going up.
And you have like a Citigroup trading at a premium to book. And Citigroup’s had a tremendous improvement. They’ve done a lot of good stuff, but I mean, that’s the cheapest of the big banks.
All the other ones are at substantial premiums, some at two, two and a half times book value. So there are, and that’s kind of an ally I would consider probably a mid-cap, I would believe. So I agree.
I think there’s a lot of opportunity there. You got to be patient. You got to make sure that the balance sheet can handle higher interest rates.
I know that we put a lot of effort into that and to ascertaining that. But yeah, Toby, I can’t imagine October is going to be like September was. I think this is going to be one of the most misleading market months.
You look at the indexes and you don’t think much happened, but underlying that there’s a lot of drama, that’s for sure.
[Tobias] There’s carnage. And as you pointed out earlier and this is probably one of the last things that I’ll say, but the AI stocks, there’s really a handful of them, but they are gigantic. And if you eliminated everything else, you still get to like 4,400 on the index.I read that stat on Twitter, so don’t quote me, but that’s the, which it’s not 7,700, but it’s a pretty material part of the index. And you get everything else in that, like the other 3,300 points of the index. So those AI stocks, I don’t want to be an alarmist.
AI Spending Risks: Can OpenAI Justify Its Huge Funding Needs?
I use AI, I love AI. I can see that there’s this enormous demand for it and you can automate all of these great little things in the business. There’s really never been a better time to be a solo entrepreneur.
But having said that, when I look at OpenAI and I look at their obligations for what they’ve got to spend, and when they’re talking like hundreds of billions of dollars, it gives me a little bit of pause, honestly. These are pretty new businesses. They don’t have, I mean, they’ve got revenue, but they don’t have any, they’re nowhere near operating profitability.
And so they’re really relying on the kindness of strangers, continuing to finance all of this. You go through a little wobble in the market and there’s no guarantees.
[Tim] And I mean, why do you have to have chat GPT when you could have, you know, Facebook doesn’t need to make a lot of money off Muse. That’s the reality of it. You know, it doesn’t have to be a huge breadwinner for them.And yes, that’s right now, it’s not geared towards as many different categories as like a chat GPT or Claude, but it doesn’t take a tonne to turn those levers on in my guesstimation, I guess. So I would agree with you, Toby. I think that that’s a huge risk.
That would probably be what changes the dynamics of it. I mean, capital should be a lot more expensive too with rates where they are. So, I mean, what types of returns are investors going to be comfortable with, you know, allocating to that, to fund that.
So, we’ll see, Toby.
[Tobias] Well, that’s all I have time for this week. You got anything else you want to discuss? We’re good.All right, folks. We’ll be back same time next week, same channel next week. See you then.
Thank you.
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