You don’t need to pay a premium to access the US economy

You don’t need to pay a premium to access the US economy

Over the past 20 years, smaller US companies have rarely been so cheap relative to large-cap stocks as they are today. They price out a lot of bad news. In fact, smaller US companies are trading at valuations similar to markets outside the US for the first time in years – offering investors a way into the US economy without paying a premium.

US Small-Cap Stocks vs. Large-Cap Stocks: Close to 20-Year Low

American small businesses

History points to a small to moderate recovery

The last time relative valuations were this cheap, and sentiment so poor, was followed by a fantastic period of absolute and relative returns for small and midcaps.

In the seven-year period following the market peak in March 2000, small-cap stocks rose more than 70% compared to a rise of less than 10% for large-cap stocks.

This outperformance from small companies has occurred during periods when interest rates and economic growth have risen and fallen – suggesting that outperformance can arise across a variety of economic environments.

Of course, past performance is no guide to the future, but we see many similarities with the current environment.

Previous outperformance of small caps has occurred in a range of economic and rate environments

American small businesses

SMEs provide diversified exposure at the time of focus

The S&P 500 has become increasingly concentrated in a very few large technology companies. In fact, only a handful of US stocks have become so overpriced that the value of entire markets appears insignificant. For example, as of the end of August, the US “Super-7” stocks – Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla and Meta – made up a larger portion of the MSCI ACWI global index than the markets of France, China, the UK and Japan. sum.*

Smaller U.S. companies offer more diversified exposure to the U.S. economy, giving a different risk profile.

Large-cap stocks versus small-cap US stocks: economic exposure

American small businesses

Small businesses are benefiting from the shift to services and “reshoring” trends.

Small, locally oriented businesses in the United States are often better positioned to take advantage of changing trends in the American economy. Although the American consumer remains resilient, consumer spending is shifting from goods to services.

The goods economy has remained strong during the Covid-19 pandemic, while the services economy has been largely shut down. Small-cap profits are more service-oriented, which should add to favorable relative earnings growth.

Another trend that was evident before the Covid-19 crisis, but has accelerated since then, is rising capital spending in the United States. A major initiative is underway to reshut supply chains as globalization begins to decline. The US government is also offering significant incentives to encourage more domestic manufacturing enshrined in legislation through policies such as the CHIP & SCIENCE Act, and the Inflation Reduction Act passed in 2022. The 2021 infrastructure bill provides additional tailwinds.

Other factors supporting capital expenditures include efforts to reduce emissions and the need to spend on automation to alleviate labor shortages. Small business sales growth is highly correlated with growth in capital expenditures in the United States. This reflects the largely domestic focus of small companies compared to large-cap companies. This domestic exposure also insulates companies from translating non-US revenues into US dollars.

And finally… “small capital” in the US world is not always small

It is important to remember that given the size of the US economy, even “small” US-focused companies are large by international standards. This is important at a time when investors are rediscovering risk as liquidity tightens due to rising interest rates. With market valuations reaching $20 billion, US SMEs are a liquid and well-traded asset class – one ripe with opportunity.

*Source: Data as of August 31, 2023. Source: Refinitiv, Schroders.

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