By Jacob Sonenshine
Tech stocks had a rough week, but the market isn't concerned about their prospects as much as it is excited about its shiny new toy -- small-cap stocks.
While the Dow Jones Industrial Average rose 0.7% this past week, the S&P 500 index dropped 0.8% and the tech-heavy Nasdaq Composite fell 2.1%.
Part of the Nasdaq's losses are simply a reflection of where it has been. It came into the week up 18% this year, and investors have been taking profits in stocks, kicked off by Alphabet's earnings beat, which sent the stock down 6.2% on Wednesday. That provided the impetus to take profits on Nvidia, Meta Platforms, and Amazon.com, all of which had also outperformed the index.
Enter the S&P SmallCap 600. The index rose 3.6% this past week as investors rebalanced their portfolios to own a bit more of the small stuff and slightly less of the tech heavyweights. Fueling the rotation: Inflation data continue to behave. June's personal consumption expenditures price index rose 2.5% year over year, down from May's 2.6%, while second-quarter gross domestic product rose a faster-than-expected 2.8% -- though nothing in the data suggested overheating.
Taken together, that should allow the Federal Reserve to cut interest rates in September, as the market expects, supporting economic growth and restoring the market's confidence in sales and profits across sectors.
While it's been quite a rally -- the S&P 600 is up about 6% over the past two weeks -- small-caps should be able to keep rising, even if they may need to take a breather. "[Long] term, the rotation has further to run," writes Evercore ISI strategist Julian Emanuel.
And not simply because of interest rates. Small-cap sales are expected to increase each quarter this year, setting the stocks up for 5% year-over-year growth in 2025, on average. As long as costs don't rise too much, profit margins can increase, which is why earnings estimates call for 19% growth next year, about five percentage points higher than the S&P 500's expected profit growth next year.
The growth, should companies achieve it, would provide more than enough fuel for continued gains in small-caps. The S&P 600 trades at about 15 times expected earnings for the coming year, almost 30% below the S&P 500's 20.8 times. That's close to the widest gap since at least 2010, according to 22V Research. When the market is more confident, that gap can narrow further, as it did in 2021, 2015, and the first few years after the 2008-09 financial crisis.
"If valuations are compressed, all you need is valuations to become less compressed for these things to move up," says Keith Lerner, co-chief investment officer at Truist.
This is one time when being small-minded could pay off.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
July 26, 2024 16:37 ET (20:37 GMT)
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