Stock Pick of the Week with Momentum Securities: 03 June - Small-Caps Stocks
Momentum’s leading stockbroking division – Momentum Securities – will be bringing you their Stock Pick of the Week, each week on a Wednesday or Thursday. The stock pick motivation is available as written content and a downloadable video and audio clip.
This week’s pick: Small-Caps Stocks
About: Small-cap stocks are public companies that have market capitalizations ranging from $300 million to $2 billion. Since the share prices of these companies can be very volatile, some companies in the small-cap universe, or in small-cap indexes, can have market caps significantly higher than this range at any particular time.
CEO for Momentum Securities, Francois Strydom shares his insight on Small-Caps Stocks
Click here to download:
• the audio clip
• the video clip.
“We are still talking about the global post Covid pandemic recovery in the markets, obviously supported by the fiscal and monetary support and thus far we’ve been calling it the reflationary trade with the expectation of inflation coming back. But at the same time, there's an opportunity said that you’d have to look out for and in a world where growth stocks and large-cap stocks are generally seen to be well priced or priced to perfection, as some would call it, there is an element of the market, which is the global small-cap stocks and more so European small-cap stocks that actually pose a bit of an attractive option.
If GDP or nominal GDP recovers by the 6/6.5% expected within the year 2021 to 2022, small-cap stocks should be a very attractive option because generally they are about 3 times more sensitive to nominal GDP growth than their growth in large-cap counterparts. Why that might be, you ask? That's mostly because of small-cap stocks generally have high operational gearing and larger sort of fixed costs that they have to cover. But the moment that the economy sort of takes over, an economic activity improves. That becomes a gearing element in its earnings and historically has added to about a 2-2.3% premium of returns of small-caps relative to its large-caps counterparts since, I think, 1923 (if you take the data back all the way).
What's been happening in the last, let's say, year or so, is the growth in the large-cap stocks have outpaced the performance of the small-cap counterparts. And If you just go and look at the forward valuations of the 1 year forward piece of the small-caps relative to the large-caps you're actually seeing there’s a trading at a 1 standard deviation below the 10 year average. Which means just on a relative basis, small-cap stocks should be slightly more attractive.
Secondly, also, if you're following the managers PMI indices or the Purchasing Managers Indices, small-cap stocks generally are way more sensitive to that historically than what the growth of the large-cap counterparts were, and the small-cap stocks are definitely been lagging in that environment.
Between Europe and the US we would definitely advocate allocating more to European flavour, more because of what we call the grand European opening due to vaccines being implemented at a large scale, and generally the valuations between European small-caps and European large-caps seems to be pointing towards about a 12% relative outperformance between small-caps in Europe versus their large-cap counterparts.
Finally, but not least, small-cap stocks are generally well supported in an environment where treasury yields are rising, obviously because of the expectation of inflation and economic activity being healthy. But that is also conducive for credit environment where if credit spreads sort of narrow or tighten, as they call it, small-cap stocks and equity space also do fairly, fairly well. So even though we might not advocate allocating across a broad spectrum of small-cap stock at this point in time, I would definitely not hold out on picking at least a good 3-6% of small cap weightings in any portfolio at this particular point.”
