NEW YORK, Nov 21 (Reuters) - Some investors believe the
stars are aligning for small-cap stocks, as the category stands
to benefit from cheap valuations, robust economic growth and a
relatively benign impact from looming tax policy changes.
About $2.4 billion has flowed into U.S. small-cap equity
funds so far this month, already the biggest monthly inflow
since March, according to data provider EPFR. That had helped
fuel an 8% gain in the S&P 600 small-cap index as of
earlier this week since late October, doubling the large-cap S&P
500s performance in that period. The Russell 2000
, a broader small-cap index, gained about 7% over that
The small-cap indexes pared gains somewhat this week amid
fears of a COVID-19 re-emergence.
Small caps, which have a median market capitalization of
$1.2 billion in the Russell 2000, rallied in the early months of
2021 as investors bet that smaller firms would benefit more from
a broad U.S. economic reopening. They floundered in subsequent
months, when technology stocks took the markets reins amid
worries over whether the Delta variant of the coronavirus would
stifle the economic rebound. The Russell 2000 is up 19% this
year against a 25% rise for the S&P 500.
With a blistering S&P 500 rally stretching valuations on
large-cap stocks and above-trend U.S. growth expected next year,
some investors now believe small caps are a bargain.
The forward price-to-earnings ratio of the Russell 2000
compared to the large-cap Russell 1000 recently stood at
24% below its long-term average, while small caps also trade at
historical discounts on other measures such as price-to-book and
price-to-sales, according to BofA Global Research.
Smaller-cap stocks on a relative basis just look much more
attractive, said Ryan Jacob, chief investment officer of Jacob
His firms growth stock funds "probably have our highest
weightings ever" in small-cap shares compared to large, Jacob
RBC strategists said the U.S. economy is expected to expand
4% next year, compared with its long-term average of 2.5%, and
believe small caps are a pure play on domestic growth.
Analysts at BofA Global Research said the disparity in
valuations between larger companies and smaller ones suggests
high single-digit price returns annually for the Russell 2000
over the next decade compared with slightly negative annual
returns for the S&P 500.
Chuck Carlson, chief executive officer at Horizon Investment
Services in Hammond, Indiana, said his firm has added more
small-cap exposure in the past four months, including shares of
shipping company Matson and semiconductor firm Onto
"After trading pretty much sideways for seven months, you
had a pretty nice breakout," Carlson said. "We like the
The improving picture for smaller companies comes as a
relief to investors looking for ways to diversify out of the
megacap technology stocks that have led markets higher for most
of the last decade, with the top five companies alone comprising
more than 23% weight in the S&P 500.
"Now you dont have to be in a FAANG stock to get some
reasonable growth," said Mike Petro, portfolio manager of the
Putnam Small Cap Value Fund, using a common acronym for massive
tech and growth stocks such as Apple and Amazon
. "You could be in some forgotten, little small-cap
stock and get reasonable nominal growth on that."
Jacob, of Jacob Asset Management, has pared back holdings in
megacap stocks Alphabet and Facebook parent Meta
Platforms, while favoring smaller companies such as
OptimizeRx and Digital Turbine.
Some investors remain wary of small caps, which over the
past decade have lagged overall, with the Russell 2000 rising
230% against a 285% gain for the S&P 500.
Signs that yet another wave of COVID-19 is taking a greater
hold in the United States, as it has in some European countries,
could once again push investors out of economically sensitive
stocks and into technology companies, which are expected to
better weather short-term growth fluctuations.
Strategists at the Wells Fargo Investment Institute this
week urged investors to take profits on gains in "lower-quality"
small-cap stocks and move into larger-capitalization companies,
saying the economy is entering the middle phase of its expansion
where growth historically has slowed.
Others, however, believe they could be a haven of sorts if
tax policy changes backed by the Biden administration are put
into law, in particular a minimum 15% tax on companies making
over $1 billion.
Should that happen, "the impact on small-caps could be less
than on large-caps," said analysts at Ned Davis Research, which
recently began favoring small-cap stocks.
(Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili and