Small-cap stocks to see lim­ited post-Fed boost

New Straits Times - - Business -

NEW YORK: Small-cap stocks ben­e­fited from a dovish lining to the United States Fed­eral Reserve’s (Fed) de­ci­sion to raise in­ter­est rates this past week, but strate­gists warn it will take more to make th­ese pricey stocks out­per­form their larger brethren in the long haul.

The Fed on Wed­nes­day raised rates by a quar­ter of a per­cent­age point, as ex­pected, but did not flag any plan to ac­cel­er­ate the pace of mon­e­tary tight­en­ing. A less ag­gres­sive mon­e­tary pol­icy may ben­e­fit small-caps, which tend to get hit harder as bor­row­ing costs increase when rates rise.

Stocks in the small-cap space ral­lied after the Novem­ber 8 elec­tion that put Don­ald Trump in the White House as in­vestors bet Trump’s plans to cut back on reg­u­la­tions and taxes would es­pe­cially help small com­pa­nies.

That hasn’t panned out in the new year, as they have un­der­per­formed the S&P 500 year-to­date. Their near-term per­for­mance hinges on how much the profit pic­ture im­proves, but so far small-cap earn­ings have yet to re­bound in the same way that large caps have.

In­vestors con­sider small-cap stocks com­par­a­tively ex­pen­sive.

“We’re in a show-me state for small caps,” said Steve DeSanc­tis, eq­uity strate­gist at Jef­feries. “We’ve got­ten (price-to-earn­ings) mul­ti­ple ex­pan­sion, so you need earn­ings growth.”

Fourth-quar­ter earn­ings for com­pa­nies in the small-cap S&P 600 were down 1.0 per cent from a year ago, while the bench­mark S&P 500’s earn­ings rose 7.8 per cent, Thom­son Reuters data show.

An­a­lysts ex­pect profit growth for the S&P 600 in the first quar­ter of 2017, but at a rate still well be­low that of the S&P 500.

The S&P 600 is up just 1.4 per cent since De­cem­ber 31, after ris­ing 24.7 per cent last year. The S&P 500 by com­par­i­son has gained 6.2 per cent since the start of the year.

At 20.4 times for­ward earn­ings es­ti­mates, the S&P 600 looks ex­pen­sive com­pared with its longterm av­er­age of 17, Thom­son Reuters data showed. The S&P 500 trades at about 17.8 times for­ward earn­ings, also above its long-term av­er­age.

The Rus­sell 2000, a widely used gauge for small-caps, has a for­ward price-to-earn­ings ra­tio of 25.4, brush­ing against its high­est level since 2009. Its 10-year av­er­age sits at 20.7.

“Growth and the in­ter­est rate tra­jec­tory are go­ing to be two key fac­tors,” said Dan Suzuki, se­nior US eq­uity strate­gist at Bank of America Mer­rill Lynch, here.

He thinks small caps may have more room to gain in the short run, es­pe­cially if earn­ings sur­prise to the up­side, but that val­u­a­tions re­mains a neg­a­tive.

On the flip side, ris­ing rates also tend to boost the US dol­lar, which would have a big­ger neg­a­tive im­pact on large-cap multi­na­tion­als as a stronger US dol­lar weighs on off­shore rev­enues when they are trans­lated into the US cur­rency.

In­vestors also worry that any tax re­duc­tions un­der the Trump ad­min­is­tra­tion may not come for many months, or even un­til next year.

“Small-caps gen­er­ally pay more in terms of US cor­po­rate taxes,” said Ni­cholas Co­las, chief mar­ket strate­gist at Con­vergex, a global bro­ker­age com­pany based here. “You can some­what view small-caps as a bit of a proxy for con­fi­dence in the tax re­duc­tion piece of the Trump eco­nomic plan.” Reuters

Growth and the in­ter­est rate tra­jec­tory are go­ing to be two key fac­tors.”

DAN SUZUKI

Bank of America Mer­rill Lynch se­nior US eq­uity strate­gist

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