Although small cap stocks have underperformed in 2023, next year investors could see a strong rebound in them with factors in their favor, said Sam Stovall, CFRA Research chief investment strategist.
Traditionally, during the first year of a new bull market, small cap stocks have outpaced large caps by a two-to-one margin, he said during a CNBC interview.
“This time around, while the S&P 500 (SPY) was up more than 21%, the Russell 2000 (NYSEARCA:IWM) was higher by just about 3%,” he said, “and I think that’s because of the hawkish rhetoric, as well as leanings, by the Fed.”
As the Fed is likely ending its rate tightening program to curb inflation, and possibly cutting rates by the third quarter of 2024, he said, that will allow investors to “nibble at these small caps once again.”
However, earnings estimate for small caps have come down, he added. Expectations were for a 12% gain in the S&P 500 (SPY).
According to S&P Capital IQ, currently it is about 10.7%, he said.
“But we’re still looking at about an 18% rise for small cap stocks. So, while there has been a commensurate decline in small cap estimates, they’re certainly still leading the large caps.”
In addition, “we’re dealing with an extremely large discounted relative P/E for small caps,” he said. “Right now, they’re trading at a 37% discount to the relative P/E average over the last 20-plus years. So, our feeling is that there’s an awful lot of upside potential. We have been seeing a broadening of participation in the sub-industries within the S&P 1500 (SPTM), and I think that is encouraging.”
He also said that, since 1945, in the pre-election fourth quarter for first-term presidents, the S&P posted an average total return of almost 6% “and never declined,” and during the full election year, the S&P has gained in average close to 15.5% and also, never declined.
“First-year administrations, whether the president gets re-elected or not, tend to be positive for stocks,” he said. “That has been echoed by the S&P mid-cap 400 (IVOO) since 1995, and an 86% frequency of advance for the Russell 2000 (IWM) since 1980 with the only slip-up purring in 1984.”
Stovall’s S&P 500 price target is 4,575.