Exciting times are ahead as the stock market is witnessing a remarkable shift. The S&P 500 has been hitting new all-time highs in 2024, driven mainly by the big tech stocks that have soared due to advancements in artificial intelligence (AI). But here’s the twist: while large-cap stocks have been stealing the spotlight, small-cap stocks have been lagging behind, creating a massive valuation gap not seen since the early 2000s.
Let’s talk about this valuation gap. The forward price-to-earnings (P/E) ratio for the S&P 500, which represents large-cap stocks, is currently at 21.3. Meanwhile, the S&P 600, which tracks small-cap stocks, has a forward P/E ratio of just 13.9. This gap is significant and could indicate a big investment opportunity. The last time we saw a gap this wide was just before the dot-com recession in 2001.
Now, history tells us something interesting: during the early 2000s, while the S&P 500 struggled, small-cap stocks soared. From 2001 to 2005, the S&P 600 delivered a total return of 66.7%, compared to just 2.8% for the S&P 500. Even through the Great Recession, small caps outperformed, with the S&P 600 returning 109.2% versus the S&P 500’s 15.1%.
So, why are small-cap stocks undervalued now? Higher interest rates have been tough on small companies, especially those relying on debt for growth. Plus, fears of a recession have pushed investors towards larger, more stable companies. But here’s the good news: with the Federal Reserve expected to cut interest rates soon and recession fears easing, small caps might be poised for a comeback.
For those looking to capitalize on this potential shift, investing in small-cap stocks could be a smart move. You could research individual small companies, or take a simpler approach by investing in index funds like the SPDR Portfolio S&P 600 Small Cap ETF (SPSM) or the iShares Russell 2000 ETF (IWM). Another great option is the Avantis U.S. Small Cap Value ETF (AVUV), which combines low fees with smart stock selection criteria.
In conclusion, while large-cap stocks still have their place, tilting your portfolio towards small caps could be a strategic move in today’s market. Happy investing!
