Investors Spot Bargains Among Small-Cap Stocks

Shares of smaller US companies triggered a sharp sell-off in the market. Some investors say they are starting to see a deal.

The small-cap Russell 2000 benchmark is down 24% from its November record, beginning a nearly two-month decline ahead of the large-cap S&P 500 index. The S&P 500 index fell 13% year-on-year, pulling lower as investors realized hot inflation was on the horizon and the Federal Reserve was likely to raise interest rates more aggressively than expected.

Small-cap stocks often fall especially sharply during times of economic uncertainty. Small-cap stocks are often considered riskier investments: Even in good times, many companies don’t reliably make money, and that proportion increases during tough economic times towel.

Among the small-cap stocks that have struggled this year: youth clothing retailer Abercrombie & Fitch Co..

, down 41% by 2022; Shake Shack burger chain Inc.,

35% reduction; BioCryst Pharmaceuticals Inc.

, down 32%; and Customers Bancorp Inc.

down 38%.

The stock market leads the trade over time between stocks of large- and small-cap companies. While it’s hard to predict when the next round of rotations will begin, investors say some of the small-cap stocks that have fallen so far look cheaper than shares of large companies. bigger company.

“Basically, we just think small-cap stocks have fallen too hard,” said Jason Pride, chief investment officer of private equity at Glenmede.

Companies in the Russell 2000 had an average market value of less than $1 billion at the end of April, compared with nearly $30 billion for companies in the S&P 500.

If the small-cap’s recent performance is any guide, other investors are also questioning the magnitude of the recent drop. Since closing at the 2022 low on May 11, the Russell 2000 has gained 8% while the S&P 500 has added 4.2%.

Strategists at BofA Global Research wrote in May that the Russell 2000 has fallen far short of the average decline during a recession, while the S&P 500 has fallen about half of its average decline. Depression.

“If recession probabilities continue to increase, both indices are likely to fall further – but historical moves suggest greater downside risk potential than current levels for the large scale,” they said. rather than small”.

The Russell 2000 traded at the end of April at 12.5 times its projected earnings for the next 12 months, below the 15.4 times average since 1985, according to BofA. That valuation puts the small-cap benchmark at the cheapest of the large-cap Russell 1000 since 2001.

The calculations exclude companies with no earnings, a sizable portion of the small-cap benchmark. Losing companies accounted for 29% of the market value of the Russell 2000 at the end of April, according to a Jefferies analysis based on earnings for the past 12 months.

That’s one reason small-cap stocks tend to fall at the first sign of uncertainty about the economic outlook.

“Any economic slowdown or geopolitical risk, people will care first and ask questions later,” said Will Nasgovitz, managing director and portfolio manager at Heartland Advisors. “Small cap stocks are inherently more volatile and there is only pressure on those stocks.”

The Russell 2000 fell deeper than the S&P 500 during the initial Covid-19 sell-off in early 2020, only to turn around and lead the market higher after promising vaccine trials fueled bullish hopes. stronger economic growth. More recently, small cap values ​​have faded after the Omicron variant brought reopening trading into question.

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Shares of Abercrombie fell 29% in a single session last week after the retailer posted quarterly losses and warnings of continued higher costs and slower sales growth. Shares of BioCryst Pharmaceuticals fell 38% in one trading session in April after the company said it had halted enrollment in a series of clinical trials.

Small-cap stocks have historically struggled through recessions but then outperformed in the early stages of expansion. While it’s an open question when the US economy will enter the next recession, that ultimate leadership is one reason money managers think it’s important to keep going. invest in the corporation.

Brandon Pizzurro, public investment director at GuideStone Capital Management, said: “Small-cap stocks tend to beat large-caps when you come out of recession, and especially good performance often start well before that recession is over.”

Write to Karen Langley at karen.langley@wsj.com

The sell-off continued to destroy the main US stock indexes in May, although they recovered last week. WSJ’s Caitlin McCabe looks at some of the key drivers behind market volatility. Photo: John Minchillo / Associated Press

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Edmund DeMarche

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