Will there be a small- & mid-cap bounce-back?

Everyone loves a comeback story – could small- and mid-cap stocks be the next one?

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From Thrivent Asset Management, welcome to episode 37 of Advisor’s Market360™. A podcast for you, the driven financial advisor.

While U.S. small-cap 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. But history shows us that these market caps have often been the leaders during recoveries following similar economic downturns. Are small- and mid-cap stocks poised to be the comeback story after the current downturn? For an answer to that question and many more, we turned to Chad Miller, Senior Portfolio Manager at Thrivent Asset Management.

“Currently, the environment we find ourselves in is a downturn in the overall economy and, by effect, the equity markets. What we've seen is that small- and mid-cap companies have sold off more than their large-cap peers. But with 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. So, this downturn currently presents a unique opportunity to get invested in an attractive long-term asset class that can ultimately rebound and generate strong returns for clients.”

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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^® Index 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.

Miller provided a little context by telling us that these valuation spreads are utilized to inform where he and his team look for opportunities. As valuation spreads become wider, some of those growth companies in the small- and mid-cap space are becoming even more attractive relative to their large-cap peers.

“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. What that has meant is some of those small- or mid-sized companies that might have a longer duration to their valuation through ultimately being higher growth companies present pretty attractive opportunities.”

It's important to remember that while small- and medium-sized companies frequently offer solid growth potential, they often have greater price volatility, lower trading volume, and less liquidity than larger, more established companies.

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There’s no crystal ball to see into the future. And Miller added that stock analysts don’t put energy into trying to predict the performance of smaller-cap stocks in the near term. However, Miller does see the potential for strong gains over the long term.

“At Thrivent, we have no way to predict what happens in the macro economy. Setting aside the macroeconomic outlook, we just use those as opportunities when they come about and knowing that, over the long term, we will return to some type of baseline growth.”

Miller is particularly interested in companies that are focused on environmental issues, such as those with strategies to reduce emissions and water usage, and those that pursue biodiversity solutions and circular business practices.

One company that fits that narrative is Advanced Drainage Systems, which produces plastic piping for the construction industry. This company takes recycled plastic, reformulates it, and packages it down in their facilities with the aim of creating a better product for the end user. Miller said that this “virtuous circle” takes plastic out of the environment that would have been going into a landfill and instead feeds it back into construction sites for another round of use. At the same time, they’re creating jobs for the local communities.

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Miller believes that investing in small- and mid-cap companies at their current depressed valuations could pay off well over the long term. And when he and his team are able to identify solid companies that have sold off in the current market downturn, they understand what great buying opportunities they represent.

“When we get those opportunities, we shouldn't be overly focused on the short-term concerns that are happening in the economy, but rather the long-term fundamental outlook for those individual companies so that we can invest in them and create strong returns for our clients over the next five to 10 years, not the next one or two quarters that are inherently unpredictable.”

Will small- and mid-cap stocks be the comeback story coming out of the current downturn? Only time will tell. But you can be rest assured that Miller and his team will be laser-focused on taking advantage of opportunities as they arise.

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Thanks for listening to this episode of Advisor’s Market360™. All episodes are available on Apple Podcasts, Spotify, and Google Podcasts. Email us at podcast@thriventfunds.com with your feedback, questions and topic suggestions for future episodes. If you’re a financial advisor and have a story you’d like featured in a future episode, we’d like to hear it! You can also learn more about us at thriventfunds.com and find other items of interest to you, the driven financial advisor. Bye for now.

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All information and representations herein are as of September 8, 2022, unless otherwise noted.

Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product.  Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

Past performance is not necessarily indicative of future results.

Small- and mid-sized companies often have greater price volatility, lower trading volume, and less liquidity than larger, more established companies.

Any indexes discussed are unmanaged and do not reflect the typical costs of investing. Investors cannot invest directly in an index.

The S&P 500 Index is a market cap weighted index that represents the average performance of a group of 500 large-cap stocks, the S&P MidCap 400 Index represents a group of 400 mid-cap stocks, and the S&P SmallCap 600 Index represents a group of 600 small-cap stocks.

This podcast episode refers to specific securities which Thrivent Mutual Funds may own. A complete listing of the holdings for each of the Thrivent Mutual Funds is available on thriventfunds.com.

Thrivent Asset Management, a division of Thrivent, offers financial professionals a variety of investment products to help meet their clients’ needs. Thrivent Distributors, LLC, is a member of FINRA and SIPC and a subsidiary of Thrivent, the marketing name for Thrivent Financial for Lutherans.