The low interest rates, the deficits, and obviously in the extreme case when the pandemic hit, we had aggressive monetary easing as well as fiscal stimulus. And in a period of time when interest rates are low, everything looks cheap. And until the stimulus came about during the covid pandemic, there was low growth.
It's because the interest rates are higher now. Small caps are generally more levered which with increasing interest rates leads to lower profits and challenges with balance sheets.
2025 outlook: Small caps offer an inexpensive way to gain exposure to the robust US economy. Multiple favorable trends – including onshoring and increased CAPEX – may explain why Wall Street expects to see the strongest earnings gains come from small caps in 2025.
Yes, it is prudent to invest in small-cap mutual funds if you have a high risk tolerance and a long-term horizon (7-10 years). They offer higher growth potential but come with more volatility. Ensure they form a part of a diversified portfolio to balance risk.
Small-cap valuations – Attractive
We expect earnings to drive the next leg higher for small-cap share prices. Analysts are looking for robust earnings growth: 15% this year, and by over 30% in 2025 and 2026. That is ahead of the long run rate of 13% growth (see Exhibit 3).
Given the changing macroeconomic backdrop, we outline why we see potential value for investors in small caps in 2024. The consensus is that interest rates look to have peaked, with markets now pricing in cuts across many major economies in 2024, something which could prove beneficial to small caps.
Most investors think smaller companies underperform in a recession. In most cases, they are correct. However, what's less well-known is that small caps usually exit recessions quicker than assumed – outperforming large caps. This rebound can begin as early as three months into an economic downturn.
The future outlook for mid-cap and small-cap funds is cautiously optimistic. With India's GDP expected to grow at 6.5%-7% in FY 2025-26, sectors represented in under the mid and small cap indices are poised for expansion.
We expect small-cap earnings growth could exceed that of large-cap stocks in 2025, aided by easier earnings comparisons.
Overall, small-cap companies are more sensitive to interest rates than large-caps because they are, on average, more leveraged. The average Net Debt/EBITDA for companies in the Russell 2000, for example, is 3.2x, versus 1.6x for the S&P 500.
Choppy markets singe large-caps
Typically, small-caps experience sharper declines during market corrections. Second, the weakness in the economy has started reflecting in the corporate earnings. India Inc's earnings show has been disappointing, resulting in earnings downgrades.
The S&P 500 entered its current bull market in October 2022 and has since advanced 65%, led by a 130% gain in the technology sector. Investors can position their portfolios to benefit from that upside by owning the Vanguard Information Technology ETF (NYSEMKT: VGT).
Short-Term Investor. If you are investing in mutual funds for a short duration, stay away from small-cap mutual funds. Small-cap mutual funds perform well over a long period of time. However, over a short period of time, they tend to be very volatile.
Looking ahead, S&P 500 stocks are currently forecast to generate 13% EPS growth in 2025 and 13.1% growth in 2026 (versus 8.5% EPS growth in 2025), while the S&P SmallCap 600 Index is currently forecast to generate EPS growth of 20.9% in 2025 and 18.6% EPS growth in 2026 (versus minus 8.0% EPS growth in 2024), according ...
The overall quality of publicly traded small caps has deteriorated, as private sponsors help top performers stay private for longer. Instead of small caps, investors should consider actively adding exposure to U.S. large-cap value and mid-cap growth stocks.
Small-cap funds have enjoyed a record run in the past five years. The category has fetched 31% annualised returns, compared to 16% from large-cap funds. Investors continue to bet heavily on this space. Since 2019-20, the total inflow in small-cap funds has crossed Rs.1 lakh crore.
Small-cap funds are riskier than large-cap funds and may not be suitable for everyone. Small-cap companies are more sensitive to market changes and can experience sudden and wide price fluctuations. Small-cap companies are less popular and smaller in size, making their stock less liquid.
The broadening of the market and the prospect for rate cuts during the rest of 2024 may serve as tailwinds for small-caps. In addition, small-cap earnings growth is expected to outpace large-caps as we head into 2025. With that in mind, we've honed our outlook for the asset class.
In a recession, it's smart to preserve your capital by investing in safer assets, such as bonds, particularly government bonds, which can perform well during economic downturns.
The small-cap funds saw an average return of 25.69% from December 2023 to December 2024, while mid-cap and large-cap funds yielded returns of 26.91% and 14.97% during the same period. So far, the Sensex has gained 8.92% and the Nifty has risen 9.49% in 2024.
Rebound Potential: The initiation of rate cuts by central banks, signalling a move towards a more normalised interest rate environment, could reduce the performance gap between small and large cap stocks. This environment may favour small cap stocks, indicating a potential rebound.
But analysts and investors are increasingly optimistic about small-caps' potential to outperform large-caps in the months ahead, driven by the likelihood that the U.S. won't fall into a recession and that interest rates will fall by as much as 1.5 percentage points by the end of 2025, says Sam Stovall, chief investment ...