David Vs. Goliath: Why Small Caps Killed Large Caps As Inflation (Barely) Softened (2024)

FAQs

Why do small caps do well in inflation? ›

June's CPI report was welcome for small cap stock prices because smaller companies generally rely on borrowing to fund operations. As inflation cools, the expectation that the Federal Reserve (Fed) will cut rates increases, therefore, creating a lower cost of capital for debt-dependent companies.

1. Small Caps Should Be a Part of Every Balanced Portfolio. Historically, small cap stocks have generated higher returns than their larger peers over extended periods. That's because smaller businesses are earlier in their maturation and have more room to grow than larger companies.

Large caps tend to be more mature companies, and so are less volatile during rough markets as investors fly to quality and become more risk-averse. Shares of small caps and midcaps may be more affordable for investors than large caps, but smaller stocks also tend to have greater price volatility.

For U.S. small cap equity, there are three leading benchmarks: the MSCI U.S. Small Cap 1750 (“MSCI”), the Russell 2000 index (“Russell”), and Standard & Poor's SmallCap 600 index (“S&P”).

Several factors have contributed to small-cap underperformance, including (1) a decline in the average quality of companies included in small-cap indexes, (2) the greater rate sensitivity of small-cap stocks during a period of tighter monetary policy, and (3) muted M&A activity, which otherwise tends to benefit small- ...

Small caps can be used to draw attention to the opening phrase or line of a new section of text, or to provide an additional style in a dictionary entry where many parts must be typographically differentiated.

Given the changing macroeconomic backdrop, we outline why we see potential value for investors in small caps in 2024. The consensus is that interest rates look to have peaked, with markets now pricing in cuts across many major economies in 2024, something which could prove beneficial to small caps.

Investing in small caps during recessions has generated superior investment returns, according to our back-testing of the data to the late 1980s (see Table 1, below).

To some, that means small caps have room to run. At the end of May, while large-cap stocks traded at fair value, "US small-cap stocks were the most undervalued compared to their long-term fair value, offering approximately a 20% discount to fair value," says David Sekera, chief US market strategist at Morningstar.

Large caps are considered safer than small caps and have performed well over time.

Is it better to invest in small-cap? ›

Small-cap stocks are a riskier investment than large-cap stocks. The companies usually have less access to investment capital and are more sensitive to market changes. This makes them a riskier investment.

These companies are known for their consistent performance and stability, even in turbulent times. Their stock prices are more stable, with less volatility than those of smaller companies. This stability can lead to reliable growth over time, making large-cap stocks a preferred choice for long-term investors.

The S&P 500 and NASDAQ 100 outperformed small caps (Solactive 2000) by more than 16% and 18%, respectively. Since the midpoint, however, the tables have turned. Small caps have rallied over 9% compared to just over 2% for the S&P 500, and less than 1% for the NASDAQ 100.

Valuation Concerns

The small-cap and mid-cap segments have historically been associated with higher growth potential compared to large-cap stocks. However, their volatility and risk are also proportionately higher.

During periods of dollar increases of 15% or more, Small-Caps, as represented by the Russell 2000 Index, has achieved an annual total return of 13.2% versus 10.3% for the S&P 500, which represents Large-Cap stocks.

Small-cap stocks typically exhibit higher volatility compared to large-cap stocks. Investors with a higher risk tolerance and a willingness to capitalise on market fluctuations may find small-cap funds suitable for their investment objectives.

Price controls in economics are restrictions imposed by governments to ensure that goods and services remain affordable. They are also used to create a fair market that is accessible by all. The point of price controls is to help curb inflation and to create balance in the market.

Most economists now believe that low, stable, and—most important—predictable inflation is good for an economy. If inflation is low and predictable, it is easier to capture it in price-adjustment contracts and interest rates, reducing its distortionary impact.

In July 2024, U.S. small-cap stocks outperformed large-cap stocks after lagging for the first half of the year, driven by a cooler inflation report and improved market sentiment.