© Reuters. Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, US, May 11, 2023. REUTERS/Brendan McDiarmid
By Louis Krauskopf
NEW YORK (Reuters) – A rally in U.S. stocks has left small businesses behind, in a sign that investors may be preparing for future economic turmoil.
Small capital decreased by about 1% this year, compared to the rise that was reinforced by it, which is an indicator that represents the largest American companies, by 7% from the beginning of the year to date.
Like an inverted US Treasury yield curve and strength in gold prices, weakness in stocks of smaller companies — which tend to take profits domestically and are more vulnerable to economic shifts than large companies — is one of several signs that investors are uneasy about the economy. prospects.
Small cap stocks have struggled since the outbreak of unrest in US regional banks in early March, with the Russell 2000 down 7% since March 8.
Investors are “trying to position their portfolios the way they think it’s going to happen in the economy,” said Eric Kobe, chief investment officer at Northstar Investment Management, which specializes in small companies. “Small companies being unfavorable is another sign that investors are bracing for an impending recession.”
Small businesses tend to waver before economic weakness in the past. Since 1980, the Russell 2000 has lagged behind the S&P 500 by an average of four percentage points in the six months after the peak of the economic cycle, before a recession hit, according to data from Strategas.
Economic data so far has shown few signs of a sharp decline in growth, although inflation and some other important measures have softened. However, some market participants believe that the Fed’s 500 basis point interest rate hike over the past year is just beginning to affect the economy.
said Michael Aron, chief investment analyst at the firm State Street (NYSE: Global Advisors). “Usually in recessions, small businesses underperform.”
At the same time, investors worry that banking instability could hurt smaller US companies that rely on loans from regional banks, which have been at the heart of the latest crisis.
An April survey by the National Federation of Independent Business found that 67% of small business owners use a small or regional bank, 17% use a medium-sized bank and 14% use a large bank. Smaller bank stocks have been hit particularly hard in recent weeks while financial institutions are also more represented in indices that track small-cap stocks, accounting for some of their weakness relative to the S&P 500.
Samir Samana, Senior Global Market Analyst Wells Fargo (NYSE: Investment Institute (WFII). Last month, it downgraded its view of small businesses in the United States from “unfavorable” to “most negative.”
“For their borrowing, they don’t have the same kind of options as maybe a larger company has,” Samana said.
Investors will focus next week on economic data including monthly retail sales and earnings reports from companies including Walmart (NYSE:) Inc, Home Depot Inc (NYSE:) and Cisco Systems Inc (NASDAQ:).
Some investors are more sanguine about the outlook for small companies, especially when looking beyond the next several months.
One reason is that small businesses, being sensitive to economic fluctuations, tend to shine early in a market recovery. Among the past six bear markets, the Russell 2000 posted an average total return gain of 44.8% in the six months following a bear market bottom, versus a 32.2% gain for the S&P 500, according to brokerage Edward Jones.
Small companies are also historically cheap as investors worry that large-cap stocks are becoming too expensive, with the S&P 500 rising this year to defy uncertain earnings expectations.
The small-cap S&P 600 trades at a price-to-earnings ratio of just over 13 times, compared to a 10-year average of 18.2 times, according to Refinitiv Datastream.
The company is overweighting small US caps in multi-asset portfolios, said Tim Murray, multi-asset group capital market strategist at T. Rowe Price, noting that it has experienced “a lot of pain” amid widespread recession fears.
“A lot of investors are going to be nervous now about leaning into smaller companies,” he said. But “the upside that you get in small businesses in general is front loading and (it comes very quickly after) recession pricing.”