Now may be the right time to invest in small-cap stocks, says Antony Creighton, director and head of strategy for Asia ex-Japan at Lazard Asset Management, which oversees more than $205.2 billion in assets. The segment has likely hit bottom in terms of relative valuation, but with the Fed easing cycle getting started, small caps are now at an “inflection point,” Creighton explains. At the same time, he stresses the importance of carefully picking where in the segment to invest.
Details
For the past year and a half, small caps have been largely out of favor. The growth in the broad equity market has rather been driven by just a few companies, namely the so-called “Magnificent Seven” stocks and several AI-related names, such as Broadcom. Now, Creighton believes “there might be time for a cyclical upshift in small-cap performance generally,” laying out the case in an interview with the Asian market-focused news and research site Fund Selector Asia. He points to two main factors.
The first is Fed rate cuts. In September, the Fed lowered rates for the first time since 2020, delivering a cut of 50 basis points. Lower borrowing costs are especially important for smaller companies, which tend to carry more debt than large companies and typically have a higher proportion of floating-rate debt, Creighton points out.
The second factor is the attractive valuations of many small-cap stocks.
“Take the Russell 2000, they’ve been growing earnings, but they’ve consistently been seeing devaluation versus large cap. We think it’s got to a point now, with the Russell 2000 on about 15x, and the S&P 500 is on about 26x. And we think there’s scope for small caps to close that gap a bit, maybe not all the way, but they’ve reached a point in our view where it’s as cheap as it’s going to be,” he says.
Why investors should be cautious
Though it is an “exciting time” to be looking at the small caps, Creighton cautions that quality is key.
“There’s a lot more chaff than wheat. There’s a lot more noise than signal. You need to be very disciplined and have a differentiated approach to be able to capture [good opportunities],”Creighton says.
Small caps remain the most inefficient, labor-intensive, and exciting segment of the equity markets, with hundreds of companies with little or no analyst coverage, said Chuck Royce, the legendary small-cap investor and founder of Royce Investment Partners, in a recent interview with Barron’s.
The best approach for a beginner investor is to diversify risk by buying shares of ETFs that track indexes like the Russell 2000, Russell Microcap, and S&P SmallCap 600, advises Georgiy Timoshin, a financial analyst at Freedom Finance Global.
