June so far has witnessed a stunning surge in small-cap stocks, with investors reaping substantial profits. The S&P 600 Small Cap ETF alone has seen its collective market value increase by a whopping $75.7 billion since the start of the month, surpassing the $52 billion gain achieved by Apple (AAPL) throughout the year. More than 91% of small-cap stocks have experienced upward momentum, outpacing the 87% of the S&P 500 that have seen gains during the same period. This resurgence in small-cap stocks represents an eagerly awaited opportunity for investors, as historically, these stocks have demonstrated slightly better long-term performance compared to the S&P 500.
Small Caps Outperforming
According to data from IFA.com, the IFA U.S. Small Company index has achieved an average annual gain of 11.1% since 1928, surpassing the S&P 500’s annualized gain of 9.9% during the same period. While small-cap stocks have lagged behind the S&P 500 and Nasdaq Composite this year, they are exhibiting stronger trends, as noted by RBC Capital Markets. The Russell 2000, an index tracking U.S. small-cap stocks, has seen modest gains of around 2.8% in 2023, while the S&P 500 has jumped 11.7%, and the Nasdaq Composite has surged 26.8% according to FactSet data.
Optimism for Small Caps
Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, said in her weekly podcast that the valuations of the Nasdaq appear stretched, while the S&P 500 and Russell 2000 remain below recent peaks.
Calvasina highlighted that small-cap stocks are starting to participate in the recovery of earnings per share (EPS) revisions. She stated that the rate of upward EPS estimate revisions for the Russell 2000 has increased to 50%, with over half of the index’s sectors experiencing positive revisions for both EPS and revenues. The note from RBC Capital Markets indicates that small-cap stocks typically bottom out three to six months before EPS forecasts begin to rise again, suggesting a potential upward trajectory.
Circor, a Massachusetts-based manufacturer of flow and motion control products for aerospace and industrial industries, has witnessed a staggering 65% increase in its stock price during June alone. What set it off was the June 5 announcement that KKR agreed to acquire Circor for $49 per share in cash. That’s a premium of 55% to Circor’s closing price on June 2, and sent shares soaring skyward. This rally has translated into more than $380 million in gains for investors, with prominent holders including BlackRock and Vanguard. Analysts are optimistic about Circor’s growth, projecting a profit increase of over 13% to $2.07 per share this year.
Another notable case is PacWest Bancorp, whose shares have surged by 41% this month. Despite a previous downturn due to concerns over regional bank instability, analysts anticipate a profit decline of over 60% in 2023, followed by a nearly 14% rise in 2024.
The discount consumer retailer Big Lots has also experienced a significant increase, with its stock rising by 40.6% in the month thus far.
Proceeding with Caution
While the resurgence of small-cap stocks may indicate a repositioning by investors towards these companies in anticipation of a recession or the eventual recovery of the U.S. economy, analysts still advise caution.
Paul Baiocchi, chief ETF strategist at SS&C ALPS Advisors, told MarketWatch the resurgence in small-cap stocks may mean that investors are starting to reposition toward small-cap names either in anticipation of a recession, or for the eventuality of the U.S. economy coming out of a recession.
Although fading recession concerns and cheap valuations are making small-cap stocks look mighty attractive right now, blindly chasing a rally is not without risk, Baiocchi warned.
Many of the small-cap companies, often technology startups and healthcare companies in the biotech space, don’t have strong profitability, which is now a bigger problem than five or 10 years ago when the Fed established a near-zero target range for the federal funds rate, said Baiocchi.
Small caps’ market performance tends to be hindered in a rising rate environment because the increased cost of debt impedes their ability to borrow capital for growth.