Ready for a comeback? Think small

With unemployment and interest rates low, and consumer confidence levels high, the US equity market has continued to outperform most others. It’s important to point out that much of this outperformance has been driven by large-caps, which outperformed small-caps by more than 15% over the past year. However, with concerns of a recession looming, valuations often come back into focus.

As seen in the chart below, small-caps, which historically trade at higher valuations relative to large-caps, are currently trading at a deep relative discount. As of August 31, 2019, small-caps, as measured by the Russell 2000® Index, had a price-to-earnings (P/E) ratio of 15.1 versus 17.0 for large-caps, as measured by the Russell 1000® Index – a 19% discount to its 10-year relative average.

Small-caps trading at a deep relative discount

small-caps trading graph

Note: P/E measures exclude negative earnings. Forward P/E is on I/B/E/S consensus next-12-months forecast earnings.

Sources: BofA Merrill Lynch US Equity & Quant Strategy, Russell Investment Group, I/B/E/S, and Compustat. Time period is 10 years

from August 2009 to August 2019.

What this means for investors:

The search for investment growth remains a central, critical goal for today’s investors, but finding a reliable source at attractive valuations can be challenging. In addition to the relatively attractive valuations discussed above, small-caps’ estimated 3-5 year earnings per share (EPS) growth compares favorably to that of large-caps, at 16.7 versus 13.3, respectively. We believe there is an opportunity for small-caps to potentially provide that solution.

Unless otherwise noted, the source of the financial data is FactSet.

Past performance does not guarantee future results.

Investing involves risk, including the possible loss of principal.

Investments in small and/or medium-sized companies typically exhibit greater risk and higher volatility than larger, more established companies.

The price-to-earnings ratio (P/E ratio) is a valuation ratio of a company’s current share price compared to its earnings per share. Generally, a high P/E ratio means that investors are anticipating higher growth in the future.

The Russell 2000 Index measures the performance of the small-cap segment of the US equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index, representing approximately 10% of the total market capitalization of that index.

The Russell 1000 Index measures the performance of the large-cap segment of the US equity universe. The Russell 1000 Index is a subset of the Russell 3000 Index and includes approximately 1,000 of the largest securities based on a combination of their market capitalization and current index membership.

Frank Russell Company is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company.

Index performance returns do not reflect any management fees, transaction costs or expenses. Indices are unmanaged and one cannot invest directly in an index.

The views expressed represent the investment team's assessment of the market environment as of September 2019 and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice.

All third-party marks cited are the property of their respective owners.

Think bigger is better?
Think again. Think small.

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