A Case for Small Caps?
Small capitalization stocks are companies with market capitalizations of $2.3 billion or lower. Historically, these companies have had faster growth potential than larger companies but carry a higher level of risk. In 2022, small and large capitalization stocks have largely moved in tandem. Through Wednesday of this week the Russell 2000 small cap index was down 18.7%, while the large cap benchmark was down a similar 19.9%. As the chart below shows, through quarter end, this was one of the worst starts for small caps on record. What is important to note is on average, following the worst nine month start of the year, small caps returned a positive 8.5% over the next twelve months and over the next three years returned on average 16.4%.
Fourth-Worst Nine-Month Start for Small-Caps Since the Early 1930s
Heading into 2022 one of our seven views was that U.S. small and mid -cap companies would benefit from the accelerated adoption of technologies brought forward by the pandemic. In addition, we believe they should be more agile in adjusting to higher inflation and the lingering supply bottlenecks. Despite a rough year, we believe there is a case for owning small cap stocks at our targeted levels. Small cap stocks have a higher share of revenue that comes from the U.S., so the strong dollar does not weigh heavily on the results of small cap companies. Additionally, some of the sector weights are in more favorable areas of the market such as financials and healthcare, which are both areas we think do well in inflationary environments. Conversely, some of the more interest rate sensitive areas that we view unfavorably like Utilities and Communication stocks are the lowest weights.
Our view is that in 2023 we will see some differentiation of performance within equities. Correlations have been very close all year long, but we expect that to change. Investors, and more importantly the equity market, will likely become more discriminating on what areas may do better. Small cap stocks may be one of those areas that start to outperform.
Source: Alliance Bernstein, S&P