With the Fed swiftly raising rates and the slowing of economic growth, small-cap stocks have gotten pummeled. The Russell 2000 has declined 32% from its November 2021 high through June 2022—worse than the S&P 500’s 24% drop. But that could be about to change, portends an article in Barron’s.
The Fed is poised to slow down on its fast-tracked rate increases, with the futures market factoring in a 26% chance of a 3/4-point increase in September, rather than its earlier estimate of 60%. And the Russell 2000 is now up 14.3% from that June bottom, outperforming the S&P 500’s 12.6% gain. That’s positive news for small-caps, especially as the pattern of underperforming before a recession and outperforming as a recession wanes is one that small-caps have followed in 1990, 2001, 2008, and 2020. That’s led some strategists to advise investors to overweight their portfolios with small-caps, the article reports.
Small-caps need to price in both the interest rate hikes as well as the recession in order for this approach to work. But their valuations would indicate that they already have; as the article points out, the Russell 2000 traded at 13 times 12-month forward earnings, almost the lowest it’s been since the 2008 financial crisis. Still, investors need to sift through some of the junk in small-cap indexes to find high-quality companies. Look for stocks that have a solid earnings-growth outlook, but are currently profitable and unlikely to have to raise capital if the market drops again, Barron’s suggests.
Citing information from Jefferies strategists, the article highlights a handful of companies that fit the bill: Armstrong World Industries, Capri Holdings, and Yeti Holdings. Yeti, the $4.4 billion manufacturer of high-end coolers, has stolen market shares away from other well-known names Igloo and Coleman by patenting technology that allows its coolers to stay cold for longer. And its added new products, indicating a solid capacity for growth. With sales predicted to compound at a 12% annual rate, bringing earnings per share up 15%, through 2024, its currently trading at 15 times forward earnings—a prime example of a small-cap stock with outsized prospects.