Wall Street Week: After a sharp decline, US small companies tempt investors with cheap valuations

The floor of the New York Stock Exchange (NYSE) is seen after trading closes in New York, US, March 18, 2020. REUTERS/Lucas Jackson

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NEW YORK (Reuters) – Shares of smaller US companies have outpaced the broader stock market as they attract investors looking to buy cheap value stocks and those who bet the group has already pricing in an economic slowdown.

Small cap Russell 2000 (.RUT) jumped 10.4% in July versus a 9.1% gain for the S&P 500 (.SPX), its biggest month-over-month percentage performance since February.

Smaller large companies tend to be more inward oriented, less profitable and have a heavier debt load than their larger counterparts, often putting them in the firing line when concerns about the economy prevail and markets become volatile.

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This year was no exception: The Russell 2000 index fell 16% in 2022 despite the July rebound, compared with the S&P 500’s 13.3% decline, as the Federal Reserve tightened monetary policy faster than expected to fight overheating inflation and exhausting risk appetite. markets.

The small cap index is now at its lowest against the big cap Russell 1000 (.RUI) since March 2020, according to Jefferies data, catching the attention of some bargain-hunting investors.

“There has been a tremendous amount of damage in the small business space,” said Francis Gannon, chief investment officer at Royce Investment Partners. “This is among the cheapest segments of the US market.”

Gannon is increasing positions in small businesses, with a focus on industrial, materials and technology companies in the space.

Some investors also believe that prices for small businesses – seen as more in line with the fluctuations of the economy – may already reflect a potential recession, limiting their downside if expectations come true.

This week’s data showed US GDP contracted for the second consecutive quarter, meeting the often-cited definition of recession. Read more However, the National Bureau of Economic Research, the official arbiter of business cycles, is yet to announce a recession and Federal Reserve Chairman Jerome Powell said this week that the economy is unlikely to be in one, citing a strong employment background.

RBC Capital Markets analysts said in a report earlier in July that small businesses appear to be “already experiencing a lot of economic pain”.

They added that “recessions tended to be good buying opportunities for small businesses.”

The bank also noted that the forward price-earnings ratio in Russell 2000 has been trading in the 11-13 times range, “which tends to define its bottom.”

“The spectrum of stocks in the down market appears to be closer to pricing in a recession than their big-cap counterparts,” Citi US equity strategists wrote earlier this week.

Not everyone was convinced it was time to buy beanie hats. The appetite for small-cap stocks could deteriorate rapidly if inflation continues and the Fed is forced to raise interest rates more aggressively than expected, further hurting the economy.

The central bank has raised interest rates by 2.25 percentage points already this year as it battles the worst inflation in four decades, but Powell offered little specific guidance on what to expect next during his press conference after the Fed meeting on Wednesday. Read more

“There could be more disappointing economic news even though the market is (already) pricing in a somewhat mild slump,” said Angelo Corcavas, an investment analyst at Edward Jones, who recommends clients “cut the weight” of small caps for now. “.

The strength of the economy faces a major test next week, when the monthly US jobs report for July is released. Economic data is expected to be of particular interest to market sentiment in the next couple of months to give clues to the Fed’s next moves.

Analysts at Wells Fargo Investment Institute said small businesses will be challenged to maintain profitability and healthy cash positions as the economy slows. The company predicts that the US economy will be in recession in the second half of 2022 through early 2023.

“We don’t think this move in small businesses has legs,” said Samir Samana, senior global market analyst at The Wales Institute.

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(Reporting by Louis Krauskopf and David Randall in New York; Editing by Matthew Lewis

Our Standards: Thomson Reuters Trust Principles.

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