In this month's Eye on The Market's special edition whitepaper titled "The Lion in Winter", Michael Cembalest, Chairman of Market and Investment Strategy for J.P. Morgan Asset & Wealth Management, shares his thesis that "While poor profit fundamentals argue against a prolonged period of outperformance vs large cap, small cap stocks are at their cheapest levels in the 21st century with potential market and political catalysts in their favor."
Key insights from the whitepaper include (full document below this synopsis):
1. Small cap stocks have underperformed large cap stocks since 2010, reversing a long-term trend of outperformance from 1930 to 2010[1].
2. Small cap stocks are currently at their cheapest levels in the 21st century relative to large caps, based on various valuation metrics.
3. The underperformance of small caps is largely due to poor profit fundamentals, particularly in the technology sector.
4. Small cap stocks tend to have lower profitability, more companies with negative earnings, and higher debt levels compared to large caps[1].
5. While US small caps have underperformed US large caps, they have still outperformed international stocks since 2010.
6. Small cap underperformance vs large cap has been primarily a developed market phenomenon, with emerging markets showing a different pattern.
7. Small cap stocks historically tend to outperform following recessions, but their performance prior to recessions is mixed.
8. Active small cap managers have generally not been able to fully offset the underperformance of small caps vs large caps through alpha generation, with some exceptions in certain categories.
9. The paper suggests that while poor fundamentals argue against prolonged outperformance, current valuations and potential market and political catalysts could favor small caps going forward[1].
Citations:
[1] the-lion-in-winter-amv.pdf
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