Small-cap stocks have finally shown signs of a breakout after underperforming for the past decade, with the Russell 2000 rallying more than 9% in July while the S & P 500 remained flat. This rally comes on the back of an improved interest rate outlook and inflation, prompting investors to bet on the asset class once again.
According to industry experts, there are several factors contributing to this resurgence in small-cap stocks. Historically, small caps have outperformed large caps by two percentage points each year since 1927, as per the Fama French 3-factor model. Analysts believe that the current rally could mark the beginning of a multi-year shift in performance for small caps.
The ongoing trend of reshoring supply chains from abroad, particularly in industries like semiconductors and pharmaceuticals, is expected to benefit small-cap companies that are domestically focused. Companies like Summit Materials, a construction materials company, and Cohu, a wafer handling company, are poised to gain from reshoring projects.
Furthermore, a steepening yield curve and an uptick in merger and acquisition activity are also factors that could boost small caps in the coming months. However, investors are cautioned about the risks associated with small-cap investments, such as lower liquidity and higher sensitivity to economic trends.
Despite these risks, experts suggest that investing in quality small-cap companies with strong balance sheets and high returns on capital could mitigate potential pitfalls. Nicholas Galluccio, portfolio manager at Teton Westwood, believes that quality can also be found in small caps, not just in large-cap growth stocks.
Looking ahead, industry experts like Mike Rode of American Century Investments and Nicholas Galluccio of Teton Westwood anticipate that the current outperformance of small caps could continue for at least the next few years. With a mix of favorable market conditions and industry trends, small-cap stocks are attracting renewed interest from investors seeking growth opportunities in the market.
