“You’re killin’ me, Smalls!” -Ham Porter in The Sandlot
We’ve liked small caps all year and we’ll be the first to admit they’ve been frustrating. But the times, they are a-changin’!
I will share a lot of charts and tables (in no particular order) as to why we think this underloved, underappreciated, and underowned area could be due for a big second half in ’24.
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- Let’s first remember the huge end-of-year rally in 2023. It was one of the best two-month rallies ever for small caps and history told us back then to expect better times over the coming year. Yes, the first six months of 2024 have been quite frustrating, but what if small caps were simply catching their breath the whole time and now are turning higher? Here’s the table we shared in December of last year that looked at the ten best two-month periods for small caps ever. The next year? Higher 9 out of 10 times and up nearly 27% on average. Not bad, not bad.
- In our just released Midyear Outlook, we noted why we like small caps (and midcaps). One of the better charts that shows this story is small caps are historically cheap. This isn’t the only reason to be bullish, but once the other drivers are in place, buying things that are cheap can be a nice way to help your portfolio. In fact, the last time small caps were this cheap relative to large caps was in 1999, which kicked off a 13-year period of outpeformance for small caps.
- Something most investors might not realize is small caps are expected to see explosive earnings growth going forward. Given we remain positive on the US economy, we think these overall earnings numbers could even come in better. Here are two nice charts showing this story.
Sources: Factset, Carson Investment Research 6/11/2024
- Small caps like rate cuts. We’ve always been in the camp that inflation would improve and the Federal Reserve would cut this year, even if two months ago no one believed us. Well, now it is looking like two (or even three) rate cuts are coming and wouldn’t you know it, but small caps tend to do quite well once the Fed starts cutting.
- Speaking of inflation, Sonu has been all over why better data on this front was coming. The one sticky part to inflation has been shelter, but we finally saw some big improvement in the data last week. Lower inflation matters, as it opens the door for the Fed to cut, which helps small caps. Read Sonu’s blog for more color here.
- Small caps don’t like higher rates. Think about it, smaller companies don’t have nearly as much fixed rate debt as large caps, so when rates rise their borrowing costs go up and it is harder for them to get financing, which limits their growth potential. In fact, large caps have locked in 90% of their debt (likely at very low rates from a few years ago), while small caps have only about half of their overall debt in fixed rate debt. Lower rates (even slightly lower) could be a big tailwind for small caps.
- The past week has been incredible for small caps, with the Russell 2000 up at least 1% five days in a row. The last time that happened was late April 2020, not the worst time to be bullish.
There isn’t a very large sample size of five-day streaks, so we looked at four-day win streaks of over 1% and the results were very impressive, higher a year later 11 out of 13 times and up a very strong 25.3% on average. It’s worth noting the worst of the 13 was fairly recent, in March 2022, and small caps were down about 20% three months later and 15% a year later. Still, we’d file the current streak in the bullish camp for small caps going forward.
Yes, we’ve liked small caps and midcaps all year. It has most definitely been frustrating, but we remain overweight these areas and expect the outperformance to continue the remainder of this year.
For more of our thoughts on small caps, I was honored to join Kelly Evans on CNBC yesterday to discuss why we like this area for investors.
For more content by Ryan Detrick, Chief Market Strategist click here.
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