While U.S. small stocks have historically outperformed their large-cap peers, the small and mid-cap categories have lagged blue chips in recent years – as well as during the current bear market. Are small and mid-cap stocks poised for a breakout after the market downturn?
“Currently in the market, we see a number of companies whose shares have been extremely punished due to the overall weakening in the economy, as well as the change in interest rates,” explained Chad Miller, Thrivent Senior Portfolio Manager.
“Within a long-term context, we know that those small- and mid-sized companies are likely to be the ones that lead the recovery on the other side of the economic downturn. That’s why this downturn may present a unique opportunity to get invested in an attractive long-term asset class that can ultimately rebound and generate strong returns for clients.”
Even before the recent sell-off, valuations of small cap stocks had already dipped well below large caps – and those valuation spreads widened even further during the bear market of the past few months. The forward price-earnings ratio of the S&P 500® was about 17 at the end of August, while the S&P SmallCap 600® Index and the S&P MidCap 400® Index were both about 12.
“As we tie that back to the valuation spreads that we utilize to inform where we look for opportunities, we've seen those valuation spreads become wider,” Miller noted. “As a result, some of those growth companies in the small and mid-cap space are becoming even more attractive relative to their large cap peers,”
While small and medium-sized companies often offer solid growth potential, they often have greater price volatility, lower trading volume, and less liquidity than larger, more established companies.