Small firms’ big gains won’t last, analysts say
NEW YORK — The stock market’s biggest gains are once again coming from its smallest companies, but the trend may not last much longer, analysts say.
Smaller-company stocks like Allegiant Travel and AK Steel have been soaring since late December and leading the rest of the market, a sharp reversal from previous months when smaller stocks were plunging more than the rest of the market.
The Russell 2000 index of small-cap stocks has jumped 19.8 percent since Christmas Eve versus 16.2 percent for the big stocks in the S&P 500 largecap index, though neither has returned to the records they set late last year.
Bed Bath and Beyond stock, for example, has surged 46.3 percent since Christmas Eve, helped by a stronger-than-expected earnings report where it said it’s ahead of plans in eventually returning to profit growth.
The Federal Reserve has pledged to be patient in raising interest rates, even though the economy is still growing, with inflation low and worries high about weakening growth. That’s a big deal for investors in smallcompany stocks because they often carry higher levels of debt than their bigger rivals, which gets more expensive as borrowing costs rise.
Stocks in the S&P 600 smallcap index have about 3.3 times more in net debt than they do in earnings before interest payments, taxes and other items. The big stocks in the S&P 500, meanwhile, have just 1.7 times more debt than earnings before interest payments, taxes and other items.
But investors shouldn’t count on this run lasting forever.
“We love the bounce back, but we don’t anticipate the momentum continuing,” Jefferies strategist Steven DeSanctis wrote in a recent report.
After their quick rebound, small-cap stocks no longer look as cheap as they did just a few weeks ago, relative to their earnings.
And if the economy is indeed in the later stages of its current expansion cycle, as many economists believe, smaller companies may be in line for a more difficult time than their larger rivals. Profit margins at smaller companies are more vulnerable to rising costs and a slowing economy, for example, say strategists at Wells Fargo Investment Institute.
So even though those strategists are forecasting similar returns for small-cap stocks this year as for other areas of the stock market, they say small-cap stocks may take investors on a more volatile ride getting there.