Bumpy times for small caps but demand still strong

Despite a high level of uncertainty in global small caps, the market may see a return to equities focusing on company fundamentals as opposed to macro events towards the end of the year, according to American Century Investments.

Senior portfolio manager, Trevor Gurwich, said consensus expectations indicated small caps would grow at a faster pace than their large-cap peers, with small cap valuations also more attractive.

“The first quarter of 2022 saw the markets largely focused on macro events, such as the Russia/ Ukraine crisis and inflationary pressures, but it’s important for investors to remain focused on longer-term earnings growth,” he said.

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“The duration of the war in Ukraine remains difficult to forecast and may continue to translate to volatility in the near term, however valuations have also compressed in small caps which may lessen the level of risk for small-cap equities as an asset class.

“In this environment, the size and diversity of the small-cap universe allows bottom-up stock pickers to identify companies whose fundamentals may benefit from supply disruption related to the crisis, including materials and renewable energy companies.”

He said that there was significant divergence in growth rates among sectors and regions, with rising interest rates, inflationary pressures, supply chain disruptions and ongoing geopolitical risk between Russia and Ukraine putting pressure on global small caps.

“This divergence is expected to continue for the remainder of this year, however some sectors, such as materials are rebounding and this will create opportunities for investors.

“The backdrop is particularly favourable for commodities such as nickel and fertilisers, due to a combination of supply disruption related to the crisis in Ukraine and a healthy outlook for demand. We also continue to see accelerating earnings growth in select companies benefiting from consumer preferences shifting towards travel and leisure-related spending.

“Conversely, the remainder of the year presents a more challenging outlook for small cap banks. Subdued bank earnings - due to slower loan growth and higher loan provisions in parts of Europe – may place continued pressure on the sector.

“Investors will need to be very selective. Our bottom-up process is finding more opportunities in insurance companies that are also beneficiaries of rising rates but whose earnings are less impacted by a deteriorating economic outlook.”

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