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).
However, the highly overstretched valuation of large-cap stocks, together with a few positive developments may shift market participants' preference from large to small-cap stocks. At this stage, we recommend small cap stocks with a favorable Zacks Rank that have strong growth potential for 2025.
Small-caps, on average, outperform large-caps by about a percentage point for the six months after a 50 basis point cut, she writes, and the majority of those periods see small-caps outperform by any degree. They average about three percentage points of superior returns over the 12 months following such a rate cut.
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.
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.
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.
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.
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 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.
The small cap segment can be extremely volatile in the short term, but they have the potential to offer very high returns over a long period. Small cap schemes are recommended only to aggressive investors with a high-risk appetite and long investment horizon, say, around seven to 10 years.
Several factors have contributed to small-cap underperformance, including (1) a decline in the average quality of companies included in small-cap indexes, (2) the greater rate sensitivity of small-cap stocks during a period of tighter monetary policy, and (3) muted M&A activity, which otherwise tends to benefit small- ...
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.
Undervalued small caps have been reliable performers over the long term. Over the last 22 years, for example, small caps have delivered an average total return of 8.1% per year. Of those years, only seven were negative; in half of the years, the asset class posted a total return greater than 10%.
Small-cap is not a bad thing, it is just that you should have the time-frame. If you're investing for any 10 year, small-cap will beat all other kinds of funds hands down, but if you are coming with a very short-term expectation, you will be very surprised in a very negative way.
To find an appropriate investment mix for your time horizon, find your age and the corresponding portfolio allocation. A typical mixture could include 60% large-cap (established companies), 20% mid-cap/small-cap (small to medium-sized compa- nies), and 20% international (companies outside the U.S.) stocks.
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.
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.
Compound interest is most powerful when it has a longer amount of time to grow your money but, still, it's never too late to start investing — even if you don't think you have enough money to dutifully invest $370 per month.
We expect small-cap earnings growth could exceed that of large-cap stocks in 2025, aided by easier earnings comparisons.
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.
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.
In July 2024, U.S. small-cap stocks outperformed large-cap stocks after lagging for the first half of the year, driven by a cooler inflation report and improved market sentiment.
Suppose you are a short-term investor and start investing in small-cap mutual funds you may lose your investment amount because small-cap mutual funds are not ideal for short-term investors as they are 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 ...