The bigger they come, the harder they fall—unless you’re talking about the stock market, where it’s the smaller they are, the bigger they fall. But after the recent decline, it’s time to buy small-caps.
While the
S&P 500
was busy hitting new all-time highs, the
S&P Small Cap 600
had fallen 7.1% from its late December peak through Jan. 18, The index, which has an average market capitalization of about $3 billion, had been hit as investors walked back their expectations that the Federal Reserve would aggressively cut interest rates. What’s more, the S&P 600 doesn’t include the fast-growing, high quality Big Tech stocks like
Nvidia
or
Meta Platforms,
to bolster the index when nothing else seems to work.
Fortunately, the reality is that the economy continues to grow and the Fed is still likely to cut rates at least a few times to keep that growth alive. That would allow small-caps to rise from their currently low levels, as they price in what should be a growing earnings stream.
“Given the sharp decline in risk factors, some bounce in high volatility, small-caps and earnings risk factors should be expected,” writes Dennis DeBusschere.
That’s why the group of equities is seeing “support,” or buyers coming in to prop the price up. The S&P 600 fell to around 1200 a few days ago, an area of support over the past few years. This means the recent drop is less likely to be a harbinger of a larger slide and more likely to be a “reset” before another rally.
This isn’t just about technicals, however. The S&P 600 trades at about 13.7 times analyst’s earnings expectations for the coming year, almost a third lower than the S&P 500’s 19.8 times. That’s near its largest discount in the past decade, according to FactSet data.
With stocks that cheap, it won’t take much to lift them higher. If consumer spending and loan demand experience moderate growth this year, that would be a boost for the consumer and financial sectors, which represent almost 40% of the index’s market value. Growth won’t be fantastic—analysts are looking for index sales growth of almost 3% annually over the next two years, according to FactSet—but could be enough to lift profit margins as cost inflation moderates. As long as companies don’t need to refinance debt at significantly higher rates, earnings can grow 12% annually over the next two years.
Cheap valuations? Solid growth? It’s time to buy the little guys.
Write to Jacob Sonenshine at [email protected]
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