What are medium small and large caps

What speaks for small and mid caps

The rotation into neglected segments has also captured the small and mid-cap stocks. Chances are they've started another bull market.

The violent sector rotation, fueled by the good news from the vaccine front, is well known. Less on the radar of many investors are the small- and mid-cap comeback that has been going on for some time.

The American Russell 2000 📈, which contains the smaller 2000 of the 3000 Russell titles, recently reached a new all-time high (see graphic). And before the Nasdaq 100, the technology index that has led the bull market since the financial crisis. "The US small caps appear to be starting a new bull market," says Daniel Haase from the Hamburg asset manager HAC.

"Since the middle of the year, the US small caps in Russell 2000 have outperformed their much better known, big brothers in the S&P 500 by a full 12 percentage points," he wrote in his latest boy scout letter, and the phenomenon is not limited to the USA. European, German and Swiss small caps have also done better than the heavyweights in their respective indices.

“The strength of the small and mid caps is program”, commented the long-time market observer Alfons Cortés recently on The Market. “The process started in May of this year and has accelerated over the past three months. It is the prevailing pattern in the US, Switzerland, the euro area and a number of countries in the Asia-Pacific region, ”he continues.

There are several reasons the little ones are making a comeback. As a rule, they benefit more from an economic upswing, now it is closer thanks to the vaccine news. This is especially true after a recession, when the central banks are stimulating and the monetary framework is correspondingly loose.

Small and mid caps trade at too large a discount

In addition, governments around the world are more willing to spend. "We are at the beginning of a new cycle that will look different from the last", write the analysts at UBS. "So far, austerity has dominated, now it is fiscal programs." And industrial, real estate and construction securities, which are strongly represented in the European indices for small and medium-cap stocks, benefit from this (the sector weights can be found at the end of the article).

As a result, the expected profit growth for 2021 between European large and mid caps has almost aligned, and the growth lead of large over small caps is also shrinking markedly. Therefore, the record high valuation premium for large caps, which was accentuated by Corona, is not justified:

In the USA, earnings expectations for the small ones are also being raised more strongly than for large caps, as reported by the US investor magazine "Barron’s". The construction and real estate market also plays an important role in the USA, contributing around a quarter to mid-cap profits and almost 40% to small-cap profits. Investments in infrastructure are also reviving small businesses in the USA.

The boom of passive investments speaks in favor of the rediscovery of small and medium-sized stocks. For years, investors have switched to exchange-traded funds (ETFs), in which large caps naturally have the highest weight. That's one of the reasons these titles left everyone else behind.

But that could turn now. "You are looking for backward values ​​again," writes Cortés. "This search leads to stocks that passively investing institutional investors give little attention to, and these are the stocks of small and medium-sized companies."

Even marginal shifts are fueling the little ones

Because the large caps have become so large, marginal portfolio adjustments can already fuel the prices of small caps. Apple alone reaches almost three quarters of the market capitalization of the Russell 2000. The FANGMAN shares - that is, Facebook, Apple, Nvidia, Google, Microsoft, Amazon and Netflix - bring in almost 8 trillion. $ and thus more than three times as much as the small-cap index:

For the stock exchanges, the strength of the smaller and medium stocks is a good sign. After two years of markedly divergent development in many sectors and individual stocks - the booming technology and health stocks contrasted with ailing energy and financial stocks - the bull market is becoming broader and therefore more stable. "Since the end of October, the median price gain in the Nasdaq 100 has been 11.8%, the S&P 500 has 14.5% and the Russell 2000 even 20.7%," writes Haase. "Small and mid caps are leading the new upswing on the stock markets."

How to invest

Active selection is particularly useful for smaller values. They are not in the focus of major international investors, and more and more banks are stopping research for less-noticed stocks. A well-informed fund manager therefore has a better chance of outperforming the benchmark index than with large caps, whose price more or less reflects all available information.

A wide range of indices is available to investors who nevertheless prefer to invest passively in ETFs. Regional peculiarities must be observed. Despite the importance of the construction and real estate sector for profit, health stocks represent the largest delegation in Russell 2000. The sector also plays an important role in the German MDax and in the domestic SMIM, but dominates the most common European benchmarks - also in Germany and Switzerland Industry values ​​(see table below).

The analysts at UBS have a sample portfolio for smaller papers in which they have included the Austrian industrial conglomerate Andritz. The title appeared for the first time this week in the monthly screening of The Market among the twenty cheapest European quality stocks. Hella - MainFirst fund manager Olgerd Eichler talks about the German auto supplier under this link - and the Düsseldorf armaments and auto company Rheinmetall, which UBS also relies on, were also represented in the selection.