Small-cap stocks in the US, as represented by the Russell 2000 index, have underperformed the broader S&P 500 index over the past year. However, there are still reasons to be optimistic about small caps. Parmenion Investment Management CIO Peter Dalgliesh believes there are ‘glaring’ opportunities brought about by small-cap valuations across a range of regions, including the UK. The firm is increasing its exposure to smaller companies and adding risk to its portfolios. Dalgliesh highlights that small caps in the UK, Europe, and the US are trading at depressed valuations, making them attractive for long-term investors. He argues that small caps are pricing in a potential economic slowdown and that the UK and European small caps are the engine room of their respective economies. Despite negative investor sentiment towards the UK, Dalgliesh sees an opportunity in the depressed valuations of small and mid caps, which have strong cash flow. He also emphasizes the diversification benefits of investing in the UK market, which has a different index composition compared to other developed markets. The UK has a significant exposure to cyclical sectors, providing additional diversification for multi-asset investors. Goldman Sachs Asset Management Portfolio Manager Greg Tuorto also highlights potential IPO and M&A activity, the upcoming earnings season, and unique thematic trends in sectors like retail and restaurants as factors that could drive small-cap outperformance. He emphasizes that small caps are closely tied to the US economy and should not be discounted, especially given the strength of the US economy. Despite recent underperformance, Tuorto's perspective suggests that small caps still offer opportunities for investors. [cdea2980] [32fe6604]
BCA Research recommends favoring the S&P Small Cap 600 Index over the Russell 2000 Index for investing in small-cap stocks. The firm predicts a recession in late 2024 or early 2025 and believes small-cap stocks will be disproportionately affected. The Russell 2000 has more unprofitable companies and lower quality measures compared to the S&P 600. The S&P 600 has lost 2.5% this year, while the Russell 2000 slipped 0.3% and the S&P 500 advanced 15%. Rising interest rates have been a headwind for small-caps. Investors can track small-cap stocks through ETFs. [62b95d21]
Investing Group Leader Peter Lynch believes that the market has been behaving abnormally, creating a rare buying opportunity. Small-cap stocks have historically outperformed large-cap stocks due to their greater growth potential and agility. The recent underperformance of small caps relative to large caps is seen as unusual and likely to revert to the mean. Small caps tend to outperform when interest rates fall, and many small caps are currently undervalued compared to large caps. Defensive small caps are expected to withstand stagflation better and benefit from a lower cost of capital if the Fed cuts rates. Some top small-cap picks include BSR REIT, EPR Properties, and Patria Investments. Investors who are willing to take on some incremental risk have the potential for significant outperformance by investing in small-cap stocks. [48223726]
On the other hand, there is caution towards US large caps due to concerns about the economy. Matt Stucky, chief portfolio manager at Northwestern Mutual Wealth Management, suggests that US small caps may be a good buying opportunity given their recession-level valuation and potential positive response to Federal Reserve rate cuts. Stucky also expresses caution about large-cap AI stocks like Nvidia, questioning the sustainability of their valuations. He believes that the return on investment of AI infrastructure and the demand levels to support these stocks in the future are uncertain. Stucky recommends considering small caps as an alternative investment opportunity. [f2472010]
Jonathan Brachle, Investment Manager at JPMorgan US Smaller Companies Investment Trust, highlights the market dominance of large-cap tech stocks, particularly the 'Magnificent Seven', which contributed nearly 70% to the S&P 500 Index's total return in 2023. The Russell 2000 Index, representing smaller US companies, is currently undervalued, trading at a Forward P/E of 14x compared to the S&P 500's 21x. Historically, small caps have outperformed large caps post-market bubbles, with expectations of 20% EPS growth for small caps in 2024 versus 12% for large caps. Brachle emphasizes the potential for diversification and growth in smaller companies, despite 39% of the Russell 2000 being unprofitable. He cites MSA Safety and Encompass Health as examples of strong small-cap investments. The Russell 2000 is still 8% below its November 2021 high, indicating room for growth. [ef51d21c]
One fund manager believes that investing in ASX small-cap shares could be attractive. Ronald Temple, the chief market strategist, suggests that non-US markets are trading at less demanding valuation multiples and could benefit from accelerating growth while US growth decelerates. He also believes that non-US companies could enjoy a more significant recovery in revenue and earnings as their economies were less resilient after the pandemic. Temple suggests allocating capital away from cash to riskier assets, such as emerging markets, Japan, small-cap, and infrastructure-related equities. However, he also warns of potential volatility in the second half of 2024 due to events like the US election and tensions over China's support for Russian aggression in Ukraine. While ASX small-cap shares are not guaranteed to outperform, they could be worth considering. [e8a3bdc6]
U.S. small-cap stocks have been performing well, but it is uncertain if Canada will see similar success. The Globe and Mail reports that U.S. small-cap stocks, as represented by the Russell 2000 index, have been on a roll. However, it remains to be seen if Canadian small-cap stocks will follow suit. The performance of small-cap stocks in Canada is uncertain, and it is unclear if they will experience the same level of outperformance as their U.S. counterparts. [d31e3bfc]
SVP and Portfolio Manager explains why an approach geared toward well-selected smaller names can help institutions now. [c33add11]