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US Strategy Comment: Small- and Mid-Cap Realities


A Shift Down the Cap Structure From Larger Companies Is Likely Premature

There is no denying the recent outperformance of small- and mid-cap indices relative to their larger cap brethren. After underperforming for several quarters, if not the past few years, small-cap companies have awakened and investors are noticing, based on our interactions with clients. However, we would classify the “need” to make the “small-cap call” as in the same vein as those trying to make an overarching “growth versus value call.” For instance, the consistent outperformance of large versus small, and growth versus value has occurred for fundamental reasons, period. However, many investors still feel encumbered to “make the call,” especially given the shorter-term nature of investor sentiment, let alone attention spans these days, in our view. We disagree with this line of thinking, especially after analyzing small and mid-cap underlying fundamentals and performance. In fact, the more “mixed” conclusions that we believe our small- and mid-cap models portray only reinforces our overarching investment strategy theme of bottoms-up stock picking relative to relying on industry, sector, asset class, and stylistic driven conclusions.

Main Points:

  • Small- and Mid-Cap Stocks Have Been in Multi-Year Price Downtrends Relative to Large-Cap Stocks

    • Despite strong MTD performance, small- and mid-caps have largely underperformed large caps in recent years

  • Sharp Rebound Expected in Small Cap Earnings Growth, but Large Cap Growth Continues to Be the Most Stable

    • While EPS growth volatility has declined in the past decade across the market cap spectrum, S&P 500 remains the most stable earner

  • Small- and Mid-Cap Valuations Look Fairly Attractive Relative to Large Caps

    • Our absolute valuation composites are all well above historical norms, but less so for the S&P 600 and S&P 400

  • Small- and Mid-Cap Free Cash Flow on the Rise, Leverage Near Highs, and ROE Exhibiting Severe Declines

    • Leverage remains elevated for small caps and mid-caps, while return on equity has faced significant declines

  • Historical Performance Relationships Could Be Key Factors in Outlooks for Small Caps and Mid-Caps

    • Relative performances for small caps and mid-caps have not responded to a widening US 10Y-2Y Treasury spread and narrowing high yield credit spreads

  • Stocks That Fit the Theme:

    • BMO OP-Rated Small Caps and Mid-Caps: Value/GARP/Growth

    • BMO OP-Rated S&P 600 & S&P 400 stocks that have outperformed their respective index since 3/23/20


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Brian Belski Chief Investment Strategist

Brian, Chief Investment Strategist and leader of the Investment Strategy Group, provides strategic investment and portfolio management advice to both institutiona...


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