For many years, the financial world has been dominated by the enormous market capitalization of technology giants. However, a noticeable shift is occurring as small-cap stocks begin to regain traction—the Russell 2000 Index has made a remarkable ascent of nearly 11% this year, albeit still lagging behind the S&P 500 which has soared by 22%. The changing landscape has ignited a debate among investors regarding the viability and profitability of small-cap stocks as a long-term investment option.
An essential factor contributing to this increased focus on smaller companies lies in the Federal Reserve’s indications of a potential decline in interest rates. Small-cap enterprises often bear more floating-rate debt compared to their larger counterparts; hence, they are typically more receptive to decreasing interest rates. This financial dynamic creates a more favorable environment for the growth of small-cap stocks.
In a recent missive, Citi’s U.S. Equity Strategist Scott Chronert detailed two pivotal elements fueling enthusiasm for small-cap stocks: their appealing valuations and a narrowing earnings growth differential when juxtaposed with larger companies. This assessment opens the door for investors to unearth opportunities where they can pay lesser multiples for a comparable growth trajectory in the near future.
Chronert argues that while maintaining a degree of investment in large-cap companies remains prudent—given their established market positions and their domination over recent years—there is an emerging narrative advocating for small and mid-cap stocks. Investors are increasingly encouraged to be discerning, targeting promising fundamental winners among these smaller entities.
Citi has further elucidated on specific small- and mid-cap stocks that warrant attention, with projections of total returns—calculated by combining capital appreciation with reinvested dividends—of 10% or more. Among the stocks that have attracted interest is Abercrombie & Fitch, the well-known retail brand. Remarkably, Abercrombie’s shares have surged by 56% in 2023. Citi anticipates a continued rise, forecasting a total return of around 33%. Additionally, JPMorgan has also shown optimism, hiking their price target to $195, which could represent an even more considerable jump of approximately 41%.
Another stock underlined by Citi is Ally Financial, a bank holding company that has fluctuated minimally over the year, registering less than a 1% increase. Yet, despite its recent subdued credit outlook, analysts perceive its current stock price as thoroughly reflecting the potential risks associated with anticipated credit and earnings scenarios. With JPMorgan upgrading its rating on Ally, the asymmetrical risk/reward situation is one that some analysts believe could be in investors’ favor.
In the entertainment space, TKO Group has also become a topic of discussion, with shares climbing nearly 43% this year. Citi predicts a total return of around 19%, while analysts highlight the company’s prospects in securing lucrative media rights fees, a reflection of the deeper pockets of tech corporations vying for sports broadcasting rights. Analyst predictions indicate that TKO could leverage higher event revenues and monetization opportunities in advertising and sponsorship as new revenue streams start to materialize.
The current market environment indicates a promising period for small-cap stocks, particularly as conditions evolve and new opportunities emerge. Taking into consideration factors such as interest rate trajectories, appealing valuations, and evolving market sentiments, a more thorough exploration of the small-cap sector could lead to profitable avenues for investors. As the investment landscape shifts, it is crucial for market participants to remain vigilant and adaptable, ensuring that they can harness the potential rewards while navigating the inherent risks within the small-cap domain. With strategic insights into emerging themes and a critical evaluation of market trends, investors could find themselves at the forefront of the ongoing small-cap resurgence.