Rising Hope for Small-Cap Stocks

Small-cap stocks haven’t had the best year so far, but brighter days might be ahead.

A significant positive influence is the rising earnings revisions. Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, recently shared that “Small-caps are diving into the earnings sentiment recovery that started in August.” She emphasized that for the Russell 2000, there’s an upward trend in EPS estimate revisions this September. The divide between small-cap and large-cap stocks on this factor is gradually narrowing.

RBC keeps its stance on suggesting a higher weight for small-cap stocks. Calvasina pointed out the historical performance of small-caps during cutting cycles and hinted that upcoming investor strategies in 2024 might lean towards more volatile trades like small-caps. This comes especially with expectations of the Federal Reserve likely reducing rates next year, after increasing the benchmark lending rate multiple times recently.

Despite lagging behind their larger counterparts this year, small-cap indexes such as the Russell 2000 and the S&P 600 have still seen some growth. On the flip side, more prominent indexes like the S&P 500 and Nasdaq Composite have seen much higher jumps.

Another catalyst for small-cap stocks could be a surge in mergers and acquisitions. Although the current deal landscape seems quiet, indicators suggest a more active M&A scene soon. A recent example is J.M. Smucker Co’s (SJM) decision to acquire Hostess for an estimated $5.6 billion. Kevin Dreyer of Gabelli Funds voiced optimism, believing that a revival in M&A activity could greatly favor small-cap stocks.

Dreyer also highlighted three stocks he’s enthusiastic about: Bellring Brands (BRBR), Atlanta Braves (BATRA), and Treehouse Foods (THS).

Bill Talbot from Manulife Investment Management noted the appeal of small-caps due to their current valuations. He mentioned that they haven’t been this undervalued relative to large-caps since the tech stock bubble of 2000. The team at his firm spots a plethora of stock opportunities particularly in tech, industrials, and healthcare sectors.

In technology, their focus is firmly on the security software domain, expecting continued revenue growth. The industrials sector looks promising due to infrastructure and domestic manufacturing boosts, partly from recent U.S. government funding, including the Inflation Reduction Act. Beneficiaries could be construction and engineering firms, materials suppliers, and manufacturers of specialized industrial products. Lastly, for healthcare, the aging American population remains a consistent positive influence.

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Rising Hope for Small-Cap Stocks

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