The next few months could remain challenging for investors, and continued high volatility and possible near-term market selloffs are likely. On the plus side, stock prices have been highly resilient in recent months, recovering quickly from declines.
Though its pace appears to be accelerating, sustained challenges in distributing vaccines could lead to worse-than-expected economic growth, which would be a negative for our modest risk-on positioning. Likewise, the sharp rallies in lower-quality stocks immediately after the U.S. election would be a risk, as we are looking for a more normalized trading environment.
In Focus: Opportunities In Small-Cap Stocks
Large cap equities dominated in 2020, but we believe the market will broaden this year. The environment for small caps began to improve in the fourth quarter amid signs of economic strengthening and promising vaccine headlines. We believe an allocation to small caps remains a vital component of a diversified long-term portfolio, with three potential catalysts leading to compelling opportunities.
Historically, small cap stocks have often outperformed the broader equity market during economic recoveries. They are more nimble and can quickly increase their workforces in anticipation of an improving economy. As a result, small caps may generate larger increases in revenues and earnings.
Small caps tend to suffer steeper declines early in a downturn as investors shift to larger, “safer” stocks. But this can create oversold conditions, which may set the stage for a stronger post-recession rebound. Notably, in 2020, the small cap Russell 2000 Index suffered a sharper decline (-31%) than the large cap Russell 1000 Index (-20%) during the pandemic-driven recession. But the Russell 2000 surged back, and outperformed its large cap counterpart, 59% versus 45%, between April and November.
Small caps have generated higher annual rates of return than any other U.S. equity or fixed income investment for nearly a century. Relative performance of small caps has varied over shorter periods, but recent dynamics suggest they may offer compelling opportunities.
Best Ideas
We believe U.S. small caps offer value and are also favorable toward emerging markets equities. Overall, our key investment theme centers on looking for quality across geographies, sectors and industries. Dividend-paying (and growing) companies should remain attractive in a low-rate environment. However, we have observed an uptick in rates in 2021 and will monitor the space.
Saira Malik is head of global equities at Nuveen.