After outperforming in September, the small-cap space is lagging again. In fact, the space is underperforming from a one-year look with the Russell 2000 Index — which tracks small-cap stocks – dropping more than 9%. The S&P 500 Index, meanwhile, is up slightly over the same time period (read: Small Caps Win in September: 5 Best ETFs & Stocks).
The beaten down prices coupled with a combination of factors seem a solid entry point for investors:
The one-year underperformance has brought small-cap valuations to their most attractive levels in years relative to large caps, presenting investors with a big buying opportunity for the long haul. Per an analyst at Jefferies, valuations for small-cap stocks are at their most attractive levels since June 2003 relative to large caps. Small caps have historically outperformed the large-cap brethren by an average of 6% over the following year when the valuation gap widens that much.
According to Bank of America Merrill Lynch, the relative P/E suggests that small caps should lead large caps over the next decade.
Small caps tend to outperform large-cap counterparts when the Fed cuts rates. The central bank has slashed interest rates two times this year to sustain a decade-long economic expansion. The speculation for a third rate cut is also ripe with market expectations for an October rate cut at 85%, according to the CME Group’s FedWatch tool (read: Chances of Fed Rate Cut in October Rise: Sector ETFs to Buy).
Lower interest rates bode well for the pint-sized stocks, perking up economic activities and resulting in higher spending, thus boosting domestically focused companies. According to Jefferies, small caps returned an average of 27.9% in 12 months after the Fed embarked on an easing cycle, while large caps gained an average of 15%.
Trade war has been playing foul on the large-cap