Australian Shares, International Shares, Investments

Small caps expected to rebound

Small-cap stocks American Century

Small-cap stock earnings are primed to return to higher levels as interest rates stabilise and fall, with investors able to benefit from their rapid repricing and return to form.

Earnings from small-cap stocks have been pushed down by higher inflation rates, which are expected to move downwards, resulting in rapid repricing and a return to form for this asset class, according to a global investment firm.

American Century senior portfolio manager Trevor Gurwich recognised there had been a significant sell-off in the small-cap sector due to rising interest rates and there had been a dramatic derating of this part of the share market.

However, speaking during a recent briefing, Gurwich added small caps bounce back strongly from negative markets and are likely to do so again in the coming months.

“What we’re seeing today is interest rate depression in the small-cap world, but we’ve seen that as well during the global financial crisis in 2008 to 2010, to a certain degree in 2016 and 2017, and again with COVID-19,” he said.

“What we are seeing is small caps being sold off because of rates that were expected to go high, but we’re at a point now where rates might stay higher for longer, but the next step ultimately is down and when that happens, small caps will start to outperform.”

He noted the small-cap universe moved through four market cycles – despair, hope, growth and optimism – and had moved into the hope phase in the last quarter of 2023 as price-to-earnings (PE) ratios started to rise and earnings per share became more stable.

“We think the small-cap universe will start to excel when it enters that growth phase when earnings start to grow and you start to get some PE rerating,” he said.

“We agree the optimism phase is where markets are at with the Magnificent Seven tech stocks, but small caps are going that way when we get an environment where inflation is under control.

“If you take a look at the global growth rates for small caps in 2024, we’re expecting about 18 per cent earnings growth and that’s across all regions. For 2025, the consensus is we are expecting an acceleration to about 22 per cent earnings growth.

“That’s why we say for a patient investor, who is looking at a 12 to 18-month horizon, it’s time now to get positioned in this asset class.

“The issue of small caps is that you never know when that green light turns on and when they rerate, they rerate very quickly.

“If we look back 70 years through prior recessions and prior big macro corrections, 13 out of 16 times you saw small caps rebound significantly faster and harder than the large-cap universe and significantly outperform that universe.”


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