'Bargain-hunting among US small caps'

The US small-cap segment has risen less than large-cap companies, but may benefit more from economic growth in the US and thus represent a good opportunity. This is explained by Matt Mahon, co-portfolio manager at T. Rowe Price, a Baltimore-based firm founded in 1937 with $1,540 billion in assets under management.

While many large caps generate most of their revenues abroad, smaller companies tend to focus on the US and are thus more sensitive to domestic economic conditions. Today, there are significant tailwinds in the consumer and corporate sectors, and this supports the strong or improving conditions of many smaller capitalisation companies. US consumers are benefiting from the strength of the labour market: unemployment is at historically low levels and average hourly wage growth is above inflation. Many are financially better off today than before Covid. Infrastructure spending and relocation of production by companies benefit small caps, especially those operating in the sectors directly affected by these initiatives. These companies range from construction materials companies to distributors to those providing the innovative tools that facilitate automated assembly lines.

On a market capitalisation-weighted basis, the S&P 500 Index depends on the fortunes of global technology and valuations incorporate high expectations for future performance. Although it is possible that these expectations will be realised, the risk of disappointment is high. In contrast, relative valuations of smaller companies have fallen to historically low levels, reflecting much more modest expectations. However, many companies continue to deliver solid results and expect good future growth. Long-term investors might consider adding exposure to small caps, focusing on those companies that drive productivity gains and/or have pricing power. While typically more volatile, smaller companies offer superior upside potential that has historically offset the additional risk. For long-term investors, we believe that a diversified portfolio of small caps can be a viable strategic allocation, capable of generating value in a variety of market conditions.

Future rate cuts could provide further support for smaller companies, but for the time being the Fed's extended pause is a favourable development.

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