The Rise and Fall of Small-Caps in the Stock Market

In the world of the stock market, the saying "the bigger they come, the harder they fall" doesn't quite hold true. In fact, it's the smaller companies that tend to experience larger drops. However, despite recent declines, now might be the perfect time to invest in small-caps.

While the S&P 500 has been reaching new record highs, its smaller counterpart, the S&P Small Cap 600, has been struggling. From its peak in late December to January 18th, the index has fallen by 7.1%. With an average market capitalization of around $3 billion, it has been greatly impacted by investors' diminishing expectations of aggressive interest rate cuts by the Federal Reserve. Additionally, the S&P 600 does not include high-growth, top-quality tech giants like Nvidia or Meta Platforms, which could provide a boost to the index in times of uncertainty.

However, there is a silver lining. The economy continues to grow, and it is highly likely that the Fed will still implement rate cuts to maintain this growth. This optimistic outlook could lead to an increase in small-caps' value, as they reflect the potential for sustained earnings growth.

Dennis DeBusschere writes, "Given the decline in risk factors, it is reasonable to expect a rebound in high volatility, small-caps, and earnings risk factors."

In conclusion, despite recent downsides, small-cap stocks have the potential for a resurgence. As a savvy investor, now may be the time to consider adding them to your portfolio.

Why Small-Cap Stocks Are Worth Considering

The recent drop in the S&P 600 index should not be a cause for alarm. In fact, it presents an opportunity for investors. The decline in price is likely just a temporary setback before another rally.

One reason to consider investing in small-cap stocks is their attractive valuations. The S&P 600 is currently trading at a discount compared to the S&P 500. This discount is one of the largest seen in the past decade, according to FactSet data. With stocks priced this cheaply, even a slight increase in demand could result in significant gains.

There are several factors that could contribute to a rise in demand for small-cap stocks. If consumer spending and loan demand experience moderate growth this year, it would benefit the consumer and financial sectors, which make up almost 40% of the index's market value. Although growth may not be extraordinary, analysts predict an annual sales growth of nearly 3% over the next two years.

Furthermore, as inflation rates stabilize, profit margins are likely to improve. As long as companies are not burdened by significantly higher debt refinancing rates, earnings could grow by 12% annually over the next two years.

Given the combination of cheap valuations and potential for solid growth, now is an opportune time to consider investing in small-cap stocks.

Contact Jacob Sonenshine for further information.