In an aging business cycle, many believe activity is more likely to slow down than to rev up and therefore profit growth will be weaker -- punishing small-caps disproportionately. Tighter margins have led to more disappointing earnings among the group and profit estimates are likely to get cut further, Wilson and his team wrote last week.
“In a late cycle environment (like the one we believe we are in), the market tends to become more discerning in terms of punishing lower quality companies,” they said.
The Russell 2000 Index of small-caps has a much lower weighting of technology companies and a higher one of financial services firms. The former sector -- beloved for its ability to generate growth regardless of the economic cycle -- has soared anew in 2020, while the latter tends to be more dependent on the macro environment.
“Investors want quality and that means big- or mega-caps,” said Gregory Perdon, co-chief investment officer at Arbuthnot Latham, a private bank in London. “High-yield is safe since rates will stay low, therefore lower re-financing risk and hunt for yield. So investors feel like nothing can go wrong.”
Still, while the Russell 2000 remains in the shadow of the S&P 500, it’s still up 15% over the past year.
“If the recovery turns out to be more robust, there is an opportunity in the more cyclical parts of the market,” the Morgan Stanley team wrote on Monday. “It is still too early to make a big bet on cyclicals or small caps but a good entry point may be approaching.”
This article was provided by Bloomberg News.