Chart Of The Week   October 08 2021

Lifting US Small Caps To Overweight

bullish small caps

The past two weeks have been characterized by a rotation in US equities. Sectors and styles that are sensitive to rising interest rates such as real estate, tech, and growth stocks have been underperforming.  Meanwhile, less rate-sensitive equities – such as financials, value, and small caps – have outperformed. Given BCA Research’s expectation that bond yields will continue rising, our US Equity strategists recommend investors embrace this rotation and shift their portfolios accordingly. Therefore, the team has upgraded small caps to overweight and downgraded large caps to underweight.

Deep cyclical sectors that tend to outperform in a rising rates environment such as energy, financials, and industrials occupy an outsized weight in small caps relative to large caps. For example, these three sectors make up 40% of the S&P SmallCap 600 index versus 22% of the S&P 500. Moreover, the rate sensitive IT sector accounts for more than a quarter of the S&P 500 versus a much lower 13% of its small cap counterpart.

Small caps are also attractive on valuation grounds. BCA Research’s relative valuation indicator which includes P/E, price-to-sales, price-to-dividends, and price-to-book reveals that small caps are the cheapest they’ve been in two decades.

We recently cited small caps’ greater vulnerability to US corporate tax rate changes as a potential headwind to the outperformance of small caps. While corporate tax hikes are a downside risk, we ultimately expect rising interest rates to support this segment of the US bourse.

View Details: US S&P 600 / S&P 500 Valuation Indicator