The time to get small cap exposure could be presenting itself if the 2023 rally fueled mostly by large-caps starts to dissipate. Small cap companies could be taking the reign and leading the rally into 2024 and beyond.
Year-to-date, the S&P 500 is up over 15% while the default small cap indicator, the Russell 2000, trails with an 8% gain in comparison. The index has been on an uptrend, however, since the start of May so a larger move could be brewing.
A Motley Fool article took a historical approach when juxtaposing the performance of large caps and small caps. In particular, they referred to the performances of the S&P 500 and S&P 600, noting that small-cap stocks “could now be the smartest pick for investors in over 20 years.”
Specifically, Motley Fool looked at the valuation gap between the aforementioned indexes, noting that the gap between the two would eventually narrow. Research suggests that price-to-earnings ratio data shows a valuation gap between large caps and small caps could mean the former is reaching its value peak, allowing small caps to eventually outperform large caps.
“Yardeni Research regularly compares the forward price-to-earnings ratios for the S&P 500 and the S&P 600,” the article said. “The forward P/E for the large-cap index currently stands at 19.1, while the forward multiple for the small-cap index is 13.4. This reflects the biggest valuation gap between the two indexes since the dot-com bubble burst in 2001.”
“However, there’s a pretty good argument to be made that large-cap stocks are overvalued right now while small-cap stocks aren’t,” the article added.
If history repeats itself, then small caps could be in an area of value, allowing for future upside.
Small Cap ETFs Over Stocks
To minimize risk, investors can opt for small cap exchange traded funds (ETFs) as opposed to individual stocks. This prevents over-concentration by essentially spreading investment capital over an array of stocks as opposed to a select few.
“Investors hoping to profit from a potential resurgence of small-cap stocks could buy individual stocks,” Motley Fool suggested. “There are thousands of them from which to choose. However, small-cap stocks can be riskier than large-cap stocks.”
Adding an extra layer of protection is getting exposure to an actively managed strategy. This is inherent in the Avantis U.S. Small Cap Value ETF (AVUV).
The fund invests primarily in a diverse group of U.S. small cap companies across market sectors and industry groups. With its low 0.25% expense ratio, AVUV invests in over 700 holdings (as of May 31), giving investors diversified exposure in one dynamic investment vehicle.
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