The massive momentum reversal in favor of small-cap stocks at the expense of large-cap stocks is likely to continue, according to strategists at Goldman Sachs.
Last week, small-cap companies posted a historic weekly performance versus large-cap companies, attributed to several factors, including slowing inflation and expectations that the Federal Reserve may cut interest rates in September.
Moreover, consistent economic growth data and the rising likelihood of Republicans winning a majority in the upcoming elections have contributed to this reversal.
“Small-cap companies tend to be highly sensitive to the U.S. economic growth environment, and they outperformed strongly after Trump’s election in 2016. Small-cap companies are also more domestically oriented than large-cap companies and less exposed to tariffs,” the analysts wrote in a report.
The investment banking giant also pointed to the compression in the earnings per share (EPS) growth premium of large-cap stocks compared to their smaller peers as an important factor.
“The recent trend of outperforming small-cap companies is likely to continue unless the macro environment changes significantly, or large-cap tech stocks report Q2 results that prompt analysts to raise revenue expectations for the next several quarters.”
The report also noted that investors are concerned about the sales outlook for big tech companies, known as mega-caps.
Investors are becoming increasingly concerned about the potential for “overinvestment” in artificial intelligence, particularly among the Big Four (AMZN, META (NASDAQ:META), MSFT, and GOOGL).
“These companies have significantly increased their planned spending on AI initiatives over the past six months, but it’s not clear when the payoff will come — in 2027, 2028, 2029, or perhaps not at all?”
This lack of growth in sales estimates is seen as a potential constraint on the performance of large-cap technology stocks.
“A potential resumption of AI trading — and thus a reversal of the recent underperformance of large-cap versus small-cap companies — will depend on earnings reviews.
The brokerage firm concluded that “outperformance will resume if large tech companies outperform and raise their future sales forecasts. If not, small caps will continue to outperform.”