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22V Surveys: Small Caps Optimism

Published on February 22, 2024

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Dennis DeBusschere

Brian Herlihy

Kevin Brocks

Sophia Wang

Quick summary, investors think:

Small caps have underperformed because of their higher interest rate sensitivity.
- Also they aren’t the mag 7.
Small caps will outperform the rest of the year.
- Investors are less optimistic about the next month (but still optimistic).
Investors are more optimistic about small cap earnings if they expect small caps to outperform.
- But there is still a group that thinks earnings will disappoint and small caps will outperform nonetheless, which implies a valuation catchup we are sympathetic to.

Why Small Caps Have Underperformed: Investors think small caps have underperformed to start the year primarily because of their interest rate sensitivity. The general consensus theme is that since small caps are less profitable (or unprofitable) and need debt to grow, they are more sensitive to borrowing higher borrowing costs. A number of clients also referenced they simply aren’t as good companies/stocks as the mag 7, and a few mentioned mean reversion after 4Q outperformance.

Small Cap Outlook: A plurality of our survey respondents expect small caps to outperform over the next month, and a majority think small caps will outperform through the rest of this year. All in, 44% expect outperformance over the next month to 36% underperformance, and 62% expect outperformance through the rest of the year to 25% underperformance. Small caps are a consensus long, despite concerns about their fundamentals in a higher rate environment.

Small caps are an even more popular long than clients expect. 44% of our survey respondents thought other respondents expect small caps to underperform. Only 25% actually expect small caps to underperform.

Small Cap Fundamentals: Expectations for fundamentals are mixed. 36% think small cap EPS growth will be lower than consensus estimates, 40% think in-line, and 23% think higher.

Investors are split on small cap eps growth relative to the S&P 500 too. 39% think small cap eps growth will be lower, 26% in-line, and 35% higher.

The fundamental expectations of the cohort that expects small caps to outperform the rest of the year is better than the cohorts that expect in-line or underperformance. That’s not surprising, but there is still a group that thinks small cap earnings will disappoint but small caps will outperform. That speaks to the intense valuation gap between small and large caps that we have been writing about (latest HERE).

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