Industry Voice: Five reasons why investors should now consider small-caps

Attractive valuations and prospects for economic recovery support small-caps

clock • 3 min read

Global stock markets have staged a remarkable recovery from their lows in late March, despite recent volatility. This rebound, however, has not been even. In the U.S., large‑cap stocks have led the way. In particular, some of the marquee growth stocks have enjoyed the best of the returns as the market has recognized that certain companies would see their economic futures pulled forward by the disruption created by the coronavirus crisis. Unusually, growth stocks have showed market leadership before, during, and after a market crisis, albeit supported by greatly superior sales, earnings, and cash flow characteristics (see chart).

Why Small-Caps Can Punch Above Their Weight

Why Small-Caps Can Punch Above Their Weight

By contrast, U.S. small‑cap stocks, as measured by the Russell 2000 Index, have performed poorly. It seems that in some cases the stock market recovery has eluded smaller companies. Empirical evidence, however, reflects that small‑caps historically outperform large‑caps over longer time periods. We have identified five potential drivers that could contribute to a reversal of small‑caps' recent underperformance.

…the stock market recovery has eluded smaller companies.

- Yoram Lustig, Head of EMEA Multi‑Asset Solutions

1. Better Immunization to Global Turmoil

Undeniably, the world faces major challenges right now. The coronavirus pandemic has decimated economic growth, with many economies remaining in deep recession as lockdown measures and disruption to global supply chains have impacted trade and services. Rising geopolitical tensions are also factors. China and the U.S. remain entrenched in a divisive trade war, and the rhetoric is heating up as we approach November's U.S. presidential election. Meanwhile, with the U.S. economy faltering, the Federal Reserve has had to slash interest rates to near zero to support growth, putting pressure on the U.S. dollar.

But turmoil in the global economy and currency markets has more of an impact on companies that rely more heavily on exports. Small‑caps, on the other hand, typically focus on local markets to sell their produce and services, making them more immune to currency fluctuations and global economic turbulence relative to large‑caps.

 

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