Why Small-Caps May Finally Bust Out of Their Torpid State

Lower rates, domestic orientations and history could produce a turnaround, Lazard says.

Now is the time for small-cap stocks, so long in the doldrums, to take wing, according to Ronald Temple, chief market strategist at Lazard. The Russell 2000, the standard yardstick for small-caps, is up just 5.4% this year, trailing the 19% of the large-cap S&P 500. Small-caps are underpriced and due for a turnaround, he contended in a research note.

Small-caps typically surge after a recession, and there has been no such downturn recently, except for the brief, pandemic-propelled one in early 2020. But Temple argued in his research that things are different nowadays. Many strategists have opined that the pandemic and its economic fallout scrambled the rules.

He noted that another time small-caps ascend is when large-caps have gotten too expensive. One example was after the tech bubble burst in 2000. Temple wrote that in “the subsequent eight years (12/31/99–12/31/07), the Russell 2000 index delivered a total return of 69%,” or 6.8% annually. During that period, the S&P 500 advanced only 1.8% yearly.

In addition, the fact that the price/earnings gap between S&P 500 and the profitable companies in the Russell 2000 multiples are wide—they usually are closer together—suggests to Temple that small-caps, or at least many of them, are poised for better days.

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As he explained: “Since 2000, the trailing 12-month P/E ratio for positive earners in the Russell 2000 index has averaged 98% of the comparable multiple for the S&P 500 index. The lowest relative valuation was in June 2000 when the Russell 2000 P/E ratio was at 51% of the S&P 500 index. As of [September 30, 2023], the ratio stood at 59% after reaching 55% in May and June 2023.” Today, it remains around the September level.

Another reason Temple is bullish on small-caps: their heavily domestic focus. The Russell 2000 index constituents derive about 90% of their revenue in the U.S., compared with around 60% to 65% of the S&P 500’s revenue. “In our view, the domestic orientation of these companies should be a positive given the expected relative resilience of U.S. growth in 2024 and beyond,” Temple declared.

Finally, Temple pointed to the widespread expectation that the Federal Reserve will lower interest rates next year. That would be an outsized boon to small caps, which tend to be more heavily in debt than large companies. Some 45% of the Russell 2000’s members have floating-rate debt, compared with just 9% of S&P 500 companies, so small-caps would benefit most from a rate easing.

Not everyone agrees. Carrie Green, director of equities for the Tennessee Department of Treasury, took issue with the notion of an imminent small cap rebound. “Small-cap valuations are cheap for a reason.” Do not expect a turnaround any time soon, she warns.

Related Stories:

Why Do Small-Caps Keep Getting Knocked Off the Game Board?

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Tech Stocks’ Multiples Too Rich to Keep Fueling S&P 500 Rise, Says Sage

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CIO Announces 2023 Industry Innovation Award Winners

The allocators driving change and enhancing institutional fund performance and the service providers driving innovation in institutional investing were recognized at the annual Industry Innovation Awards dinner.

Photography by Anthony Collins


The 2023 CIO Industry Innovation Award winners were announced at the 13th annual awards dinner in New York City on December 5.


The Asset Owner Industry Innovation Awards finalists and winners are:

Corporate DB <$20B

  • Angie Buk—3M
  • Jeanmarie Grisi—Nokia
  • Thomas Mucha—Kodak Winner
  • Carol Tusch—International Paper

Corporate DB >$20B

  • Ernie Caballero—UPS
  • Harshal Chaudhari—GE
  • Jeffrey Lewis—FedEx
  • Elizabeth Tulach—Boeing Winner

Efforts in Diversity

  • Jagdeep Bachher—University of California, Regents Winner
  • John Barker—Kresge Foundation
  • Jason Klein—Memorial Sloan Kettering Cancer Center

Efforts in ESG

  • John Barker—Kresge Foundation
  • Richard Kent—Friends Fiduciary
  • Jeff Mindlin—Arizona State University Foundation Winner
  • Aaron Moore—California State University Foundation

Endowments

  • Tim Barrett—Texas Tech University System Winner
  • Richard Chau—Tulane University
  • Sonali Dalal—University of St. Thomas
  • Marcus Frampton—Alaska Permanent Fund
  • Geeta Kapadia—Fordham University
  • Christine Kelleher—National Gallery of Art

Foundations

  • Colin Ambrose—Mother Cabrini Health Foundation
  • Leena Bhutta—Doris Duke Foundation
  • Carlos Rangel—W.K. Kellogg Foundation Winner

Health Care Plans

  • Mark Cagwin—SSM Health
  • David Erickson—Ascension
  • Josh Rabuck—Indiana University Health
  • Alyssa Rieder—CommonSpirit Health Winner
  • Rob Roy—AdventHealth

Public DB <$10B

  • T.J. Carlson—Missouri State Employees Retirement System
  • Jason Malinowski—City of Seattle Winner
  • Katherine Molnar; Andrew J. Spellar—Fairfax County Police Officers Retirement System; Fairfax County Employees’ Retirement System
  • Craig Slaughter—West Virginia Investment Management Board

Public DB $10B - $20B

  • Ted Hall—Ohio Police and Fire Pension Fund
  • Raynald Leveque—The New Hampshire Retirement System
  • Mark Steed—Arizona Public Safety Personnel Retirement System Winner

Public DB >$20B

  • Benjamin Cotton—Pennsylvania Public School Employees Retirement System
  • Scott Davis—Indiana Public Retirement System Winner
  • Andrew Junkin—Virginia Retirement System
  • Molly Murphy—Orange County Employees Retirement System

CIO of the Year
Elizabeth “Liz” Tulach, Vice President, Chief Investment Officer, The Boeing Company
Lifetime Achievement Award
Chris Ailman, Chief Investment Officer, California State Teachers' Retirement System (CalSTRS)


The Asset Management & Servicing Industry Innovation Awards finalists and winners are:

Data and Technology

  • DEF 14 Inc.
  • DiligenceVault
  • LP Analyst Winner
  • Lumenai Investments LLC
  • PitchBook
  • Venn by Two Sigma

Emerging Markets

  • Principal Finisterre
  • Vontobel Winner

ESG

  • Bailard Winner
  • Principal
  • Sage Advisory Services
  • Schroders Asset Management
  • TOBAM
  • Vontobel

Hedge Funds

  • Aspect Capital Winner
  • Lumenai Investments LLC

Liability-Driven Investing (LDI) – Large*

  • Agilis
  • LGIM America
  • NISA Investment Advisors Winner
  • Principal Asset Management
  • SLC Management

*Assets under management less than $1 trillion

Liability-Driven Investing (LDI) – Mega

  • Capital Group
  • Goldman Sachs Asset Management
  • JP Morgan Asset Management Winner
  • Wellington Asset Management

Assets under management in the trillions

Multi-Asset Portfolios

  • Goldman Sachs Asset Management
  • LGIM America
  • Lumenai Investments LLC
  • TOBAM Winner

OCIO

  • Berg Capital Management
  • BlackRock Winner
  • Goldman Sachs
  • SEI
  • TIFF Investment Management

Pension Risk Transfer

  • Agilis
  • Athene Winner
  • NISA Investment Advisors
  • OneAmerica

Private Credit

  • 17Capital
  • Apollo Global Management
  • Eagle Point Credit Management
  • Principal Asset Management – Middle Market Direct Lending
  • SLC Management Winner

Private Equity

  • 17Capital
  • Apollo Global Management Winner
  • Ariel Alternatives, LLC, private equity subsidiary of Ariel Investments, LLC

Public Fixed Income

  • Capital Group
  • LGIM America Winner
  • NISA Investment Advisors
  • Vontobel

Real Assets and Infrastructure

  • Bailard
  • Cohen & Steers
  • Principal Asset Management Winner

Congratulations to all from CIO!

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