Small and mid-cap stocks must do better
The outperformance of small and mid-cap stocks globally has been going on since the victory of Donald Trump last year. This has been quite surprising to lots of investors, markets monitor and commentators alike. The world economy has had a torrid time since the financial crises of 2008. There have been some fundamentals changes the way investors view the financial markets. At the time of the financial crises there was credible talk of the “New Normal”, put is simply is low interest rates for a long time accompanies by below trend in global economic growth. This has indeed happened and caused great pain to those who were not prepared for it.
There is no doubt that the world has changed dramatically over the past few years. Economic changes followed by political changes and rising geopolitical tensions not only in the East but also in the West. So, what all this have to do with small and mid-cap stocks outperforming bigger companies. Maybe we have not got a tight grip on what is the new US president all about and how he is going to implement his economic and fiscal agendas in the US that will have a great impact on the rest of the world. In fact, there has not been any clear policy changes going forward. But equity investors worldwide are investing heavily in small and mid-cap equities.
There are a few areas of market research that is worth studying carefully assumed Trump’s proposed agenda and evolving administration. The continuous outperformances by small and mid-cap stocks is much broader and widely based. I expect the outperformance to spread to small-cap financials, industrials and materials pulling the indices along with them. The easiest explanation for this broadbased performance is that small cap stocks are highly leveraged to the national domestic economies more than large capitalization stocks. Most of their revenues are generated domestically and they tend to have little or no exposure to foreign currency fluctuations. These are good qualities to have when the global economy is not growing strongly. Identifying those small and mid-cap stocks that are going to do well are not easy job. Investors can easily have exposure by just buying small and mid-cap indices or ETF’s (Exchange Traded Funds).
Some small cap sectors do stand out in terms of valuations and potential growth. Banks and financial stocks have been doing extremely well and they have more to go. Also, some the industrial and mining sectors are moving in the right direction at least in the US. Higher inflation and increasing interest rates can have quite good impact on the earnings of those mentioned sectors at least in the short term.
Small and mid-cap companies are great place to find big investment returns. The only problem is where and how to find them. There are hundreds or thousands of them listed on the global stock markets. The question is which ones are worth the investment. The good news is that there is an ongoing regulatory relief literally around the world that can only benefit small and mid-cap companies. Nearly worldwide policies are either in place such as in the US or elsewhere are talking higher interest rates, fewer regulations, loan growth, lower tax rate and stock buybacks suggests that earnings growth for small and mid-cap companies could easily outpace big cap stocks.
Apart from the fundamental arguments for investing in small and mid-cap stocks, I believe over the past few years investors have poured money into big capitalization and index stocks and now they are adding more money into small and mid-cap stocks. Also, they believe that there could be more stimulus measures to increase economic growth. These measures could be in the shape of tax cuts and increase in government spending.
Doing a proper research and due diligence on small and mid-cap stocks, investors could easily identify the potential future big capitalization stocks. For investors in small and mid-cap companies the task is to find which ones are growing strongly year after year. Just because they are at present domestically orientated does not mean that they cannot grow their business internationally in the future. Most big multinational companies have started being small domestic companies. It is all about strong revenue growth, innovations, creativity, expanding clients base and creating a niche market for their products. The rest will follow and investors can only gain in the long term. — @Rasameel