As the wider market rally slows down, investors are pinning their hopes on small-cap stocks, pouring $4.2 billion into the U.S. mutual funds and ETFs that buy them, reports an article in The Wall Street Journal. Meanwhile, investors have yanked $17.4 billion out of large-cap funds, and the S&P 600 small-cap index is up 8.1%, well above the large-cap S&P 500’s 2.9% climb. Three companies highlighted in the article are Community Health Systems, semiconductor provider Rambus Inc., and Asbury Automotive Group, all of which have gone up over 20% so far this year.
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While smaller companies are generally thought to be riskier and more vulnerable to changes in the market than large companies, in the past they have taken the lead in market recoveries—though they’ve also been sold off quicker during downturns. Indeed, small-cap stocks underperformed the S&P 500 last year, with funds that tracked them garnering a loss of $28.5 billion. And though the threat of a recession still looms, the U.S. economy is showing signs of strengthening, with a strong jobs market and solid consumer spending, which has given small-cap stocks a boost. Many investors are attracted to small-cap stocks due to their valuations; the S&P 500 is trading at 13.8 times forward earnings compared to the S&P 500’s 17.6 times, making them a relatively good bargain. Buybacks are also fueling the small-cap rebound, as companies that have bought back their own stock have been some of the best performers in small-cap groups that Bank of America has followed over the last 12 months, the article details.
Even with the rebound, there are risks for small-cap stocks, such as the same pressures from earnings estimates that larger companies face as well as a weakening dollar, though smaller companies are more protected from negative effects from foreign-exchanges since they do more of their business inside U.S. borders. And stocks across the the entire market are now competing with higher government bond yields, prompting many managers to trim back small-caps from their clients’ portfolios. “With bond yields being where they are, investors really have to consider the merits of making an investment into companies that have little to no profit versus becoming a creditor of the United States government and getting paid 5% for that,” Ryan Belanger of Claro Advisors told The Journal.