2023 was the year of mega caps and 2024 also started under their star. There race of the Magnificent 7as Wall Street analysts like to call it Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Teslahas overshadowed the small and mid-cap companies, which today offer low valuations and, in several cases, interesting growth prospects. He is convinced of this Tommaso TassiCountry Head Italy by Columbia Threadneedle Investments.
How are small caps positioned in the current stock market and economic context?
“Unlike illiquid asset classes, equities already reflect rising interest rates in their valuation. This was evident in 2022, when equity markets experienced a strong headwind. This negative trend reversed again over the course of of 2023 and equity markets performed very well overall, particularly in November and December last year.This is based on the expectation of a stable, perhaps even accommodative, interest rate environment in 2024. We expect a neutral to positive interest rate environment and a similar evolution of the real economy, if geopolitics are up to par. Rising interest rates and the specter of recession certainly make the environment more difficult for small caps , typically more sensitive to economic volatility given their limited liquidity and the need for borrowing to finance growth. On the other hand, however, when the market enters a recovery phase, small and mid-cap stocks also recover with more strength. Currently, many stocks that were once too expensive are now cheaper and very attractive. Additionally, the small cap market offers exposure to quality global companies with diverse profitability drivers and resilience potential. With an extremely concentrated large-cap market and smaller companies trading at historically low prices, this asset class can offer a great opportunity for portfolio diversification at an attractive price.”
The small cap segment has long been overshadowed by large caps, especially the Magnificent 7 over the past year. What are the prospects for 2024?
“In recent years, the tech giants have recorded exceptional results, increasing revenues and profits above expectations; a trend that has led these seven companies to increase their share within the S&P 500, even accounting for 28 %.However, this strong equity concentration poses risks if these companies fall short of expectations and slow their growth rate.The first signs of this change emerged at the end of 2023, when small caps returned to showing outperformance Quality small caps tend to have relatively low gearing and strong balance sheets, so they should be less affected by the need to refinance debt at higher rates, and many of these companies have pricing power that makes them resilient in the long run. times of inflation.Furthermore, many of them can also benefit from the same structural opportunities present in large caps. This could be the growth of artificial intelligence, innovation in healthcare or addressing the climate crisis. Small companies are often the enablers, providing mission-critical products or services integrated into their customers’ processes. In the US, many small and mid caps are also benefiting from infrastructure subsidies, such as the Chips Act, while in Japan the Tokyo Stock Exchange is encouraging companies to improve capital allocation. Such incentives have a positive effect in improving stock prices and increasing the interest of international investors.”
How to select the most interesting companies in the universe of small and medium capitalization companies?
“Given the macroeconomic environment, quality is probably the best way to gain exposure to small-cap companies. The collapse in prices in 2022 and the dominance of large caps in 2023 mean that many high-quality small caps are trading today At affordable prices.Additionally, since the large-cap market has focused on a handful of names, an allocation to small caps offers useful diversification not only by market cap, but also by region and sector The global universe of small caps is indeed large and presents a notable dispersion in the types and quality of the companies that compose it. In terms of perspective, it is easier for an active manager to generate alpha or outperformance with small caps than with large ones cap, as these are companies covered by fewer analysts.Furthermore, we believe that an active investment approach focused on careful stock selection has the potential to deliver returns that exceed those of the index. At Columbia Threadneedle, our Ct (Lux) Global Smaller Companies strategy, launched in 2013, has always adopted a bottom up approach, observing the positioning of individual companies in their reference market and product context, as well as their qualitative characteristics. The companies we select are characterized by a solid balance sheet, a robust margin structure and a good positioning compared to competitors; this allows them to earn above-average returns for a number of years. Our strategy looks, in particular, at companies in sectors such as industrial goods, technology and healthcare, as we believe there is the potential to achieve above-average returns thanks, for example, to patents, brand strength or leverage effects. net”.