Is this asset class really a "once in a multi-decade opportunity"?
US small cap stocks had a rousing rally after the Trump shooting. Can this last?
The Russell 2000 US small cap index posted its best returns in 12 years during the 2 middle weeks of June. It handily outperformed US growth stocks and the S&P 500 over those weeks.
This is mostly due to investors rotating from US tech stocks to small cap value stocks. Now the question is, will the US small cap rally continue?
We'll be looking at two contrasting arguments for and against small cap value stocks.
Goldman Sachs Research: Yes to Small Caps
Goldman's David Kostin believes that the small cap rally will continue, barring big changes in the macro environment or a blow-out tech earnings season that leads to further upgrades to tech.
He lists the following reasons for the small cap rally:
Imminent Fed rate cuts
Decelerating inflation
Resilience of economic growth
Increasing odds of Trump Presidency
Narrowing gap between large cap and small cap earnings growth
The Dutch fund management firm Robeco is even more bullish on small caps, calling it a “multi-decade opportunity for investors.”
Small caps are trading at a 20% valuation discount to large caps, the largest valuation gap in 20 years.
Morgan Stanley Wealth Management: No to Small Caps
Societe General's head of quantitative strategy Andrew Lapthorne thinks that the 2-week small cap rally is technically driven, a short squeeze resulting from hedge funds’ short positions. He thinks the squeeze is over.
Morgan Stanley Wealth Management's Lisa Shalett is also skeptical on this rally. She cites secular reasons for not liking small caps:
Private equity in the past decades has largely hollowed out profitable small caps.
Almost 60% of companies in the US small cap index are unprofitable.
Small cap sector mix is unfavourably leveraged to the US consumer, who is already showing signs of spending fatigue.
Fed rate cuts in this cycle are likely to be shallow and spaced apart.
Small cap stocks are still experiencing cuts to earnings estimates.
Under Trump and to a lesser extent Harris, higher tariffs will be inflationary. Growth stocks are likely to weather high inflation better than small cap stocks.
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