Small stocks have popped in the past few days, outpacing the large-cap S&P 500. The next few days will show whether that can continue.
The
an index of profitable companies with an average market capitalization of $3.8 billion, has gained 4.3% since hitting a low point in mid March. That compares with a gain of 2% for the
in the same stretch.
While the equity market overall has been in rally mode, giving both indexes double-digit gains since late October, the S&P 600 had been trading at one of the biggest discounts in history to the S&P 500 in terms of forward price/earnings ratios. That means it was only a matter of time before it began to outperform the large-cap benchmark, especially if investors were confident about growth in earnings.
And investors are upbeat. The economy continues to grow, companies’ profits are generally surpassing forecasts, and the market expects that the Federal Reserve will keep the party going by lowering interest rates.
Still, the real challenge for the S&P 600 lies ahead. While the index closed Wednesday at1336, a close at or above 1339 would go a long way in convincing the market that it can remain in an uptrend.
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The S&P 600 last closed at 1339 in late December, but sellers quickly came in, leaving the index lower for weeks. If it can surpass 1339 this time around, it means the market is becoming more confident in the economy and that the Fed is still more likely to cut rates this year than keep them unchanged.
Valuations are still unusually cheap. The index trades at 14.1 times the earnings expected for the coming 12 months, 31% lower than the S&P 500’s just over 20 times, according to FactSet. That isn’t quite the largest discount historically, but it is close.
As long as valuations remain where they are, the index can gain if expectations for the profits of S&P 600 companies continue to increase. A decline in valuations isn’t likely, given how cheaply the stocks are trading now. A higher price/earnings multiple would fuel additional gains.
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“An attractive entry point may exist for investors with a long-time horizon, since small caps are currently trading at comparably low levels,” wrote Jon Christensen, portfolio manager at Kayne Anderson Rudnick.
Small-caps can continue to see big gains.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
