Wall St Week Ahead After steep decline, U.S. small caps tempt investors with cheap valuations

Wall St Week Ahead After steep decline, U.S. small caps tempt investors with cheap valuations

The floor of the New York Stock Exchange (NYSE) is seen after the close of trading in New York, U.S., March 18, 2020. REUTERS/Lucas Jackson

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NEW YORK, July 29 (Reuters) – Shares of U.S. smaller companies are outpacing the rise in the broader stock market, attracting investors looking to pick up low-value stocks and those betting the group has already priced in an economic downturn.

The Small Cap Russell 2000 (.RUT) jumped 10.4% in July against a 9.1% gain for the benchmark S&P 500 (.SPX)its strongest percentage point outperformance on a monthly basis since February.

Small caps tend to be more domestically oriented, less profitable and carry more debt than their larger counterparts, which often puts them in the crosshairs when worries about the economy set in and markets become volatile.

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This year was no exception: the Russell 2000 fell 16% in 2022 despite July’s rebound, compared to the 13.3% drop in the S&P 500 as the Federal Reserve tightened monetary policy faster than expected to fight runaway inflation and undermined risk appetite across markets.

Small cap index now bottoms against large cap Russell 1000 (.RUI) since March 2020, according to Jefferies data, attracting the attention of some bargain-hunting investors.

“There has been a tremendous amount of damage in the small cap sector,” said Francis Gannon, co-chief investment officer at Royce Investment Partners. “It’s one of the cheapest segments in the US market.”

Gannon increased his small cap positions, focusing on industrials, materials and space technology companies.

Some investors also believe that the prices of small caps – which are considered more sensitive to fluctuations in the economy – could already reflect a potential recession, limiting their decline if predictions of it come true.

Data this week showed that US gross domestic product contracted for a second consecutive quarter, meeting an oft-cited definition of a recession. However, the National Bureau of Economic Research, which is the official arbiter of business cycles, has yet to declare a recession and Fed Chairman Jerome Powell said this week that the economy is one, citing a strong employment environment.

Small caps appear to be “already under a lot of economic pain,” RBC Capital Markets analysts said in a report released earlier in July.

“Recessions have tended to be good buying opportunities for small caps,” they added.

The bank also noted that the Russell 2000’s forward price-to-earnings ratio has traded in the 11-13x range, “which tends to bottom out.”

Earlier this week, US equity strategists at Citi wrote that “equities across the market cap spectrum look closer to recessionary prices than their large-cap counterparts.”

Not everyone is convinced it’s time to buy small caps. Appetite for small business stocks could quickly deteriorate if inflation remains persistent and the Fed is forced to raise rates more aggressively than expected, inflicting more pain on the economy.

The central bank has already raised interest rates by 2.25 percentage points this year as it battles the worst inflation in four decades, but Powell gave little specific guidance on what to expect when from his press conference after Wednesday’s Fed meeting. Read more

“There could be more disappointing economic news ahead even though the market is (already) pricing in a mild recession,” said Angelo Kourkafas, investment strategist at Edward Jones, which recommends “underweight” small caps to clients. for the moment.

The strength of the economy will be tested next week when the monthly US jobs report for July is released. Economic data should be particularly important to market sentiment over the next couple of months to provide clues for the Fed’s next moves.

Wells Fargo Investment Institute analysts said small businesses will be challenged to maintain profitability and healthy cash positions as the economy slows. The company predicts that the US economy will be in recession in the second half of 2022 and early 2023.

“We don’t think this move into small caps has legs,” said Sameer Samana, senior global market strategist at the Wells Institute.

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Reporting by Lewis Krauskopf and David Randall in New York Editing by Matthew Lewis

Our standards: The Thomson Reuters Trust Principles.

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