Source: Zhitong Finance Author: Li Junping

As the global economy gradually recovers from post-pandemic turmoil, investors are turning to more promising market segments, particularly the small-cap market. Zhitong Finance has observed that recently, the US small cap indices — the S&P 600 and Russell 2000 indices — have risen significantly, while the MSCI European Small and Medium Cap Index has also shown strong performance.

Among them, the S&P 600 Index surged nearly 23% from its October low, the Russell 2000 Index jumped more than 13%, and the MSCI European Small and Medium Cap Index rose 12% since the end of last month.

Let's take a closer look at why 2024 could be a big year for small cap stocks, and which specific stocks could be the stars of tomorrow.

There are several favorable factors that may support the growth of the small cap market in 2024. First, due to relatively low valuations, small-cap stocks are more attractive to investors. Second, it is expected that central banks around the world may cut interest rates, which will benefit the financing costs of small companies. Furthermore, earnings expectations for small-cap stocks are expected to resume growth after experiencing a decline.

Specifically, according to LSEG Datastream data, the relative value of US small-cap stocks and large-cap stocks is close to the lowest level in history. For example, the expected price-earnings ratio of the S&P Small-Cap 600 Index is 13.7 times, which is far below its long-term average and the current level of the S&P 500. At the same time, the expected price-earnings ratio for European small-cap stocks is 12.2 times, lower than the 15-year average of 15 times, and lower than MSCI Europe's current overall price-earnings ratio of 12.3 times.

Second, the market anticipates that global central banks may cut interest rates in 2024, which is good news for small-cap stocks. As small companies generally rely more on short-term debt, small stocks are more affected by rising borrowing costs, and the recent decline in government bond yields is beneficial to reducing the financial burden on small companies.

In addition, small-cap earnings are also expected to pick up. According to LSEG data, the earnings of the Russell 2000 index constituent companies are expected to increase by about 30% next year after falling 11.5% in 2023. This indicates that the recovery momentum of small-cap stocks is likely to be strongest in the early stages. In response, Amisha Chohan, head of small-cap strategy at Quilter Cheviot, believes that small-cap stocks will pick up rapidly, and the recovery momentum will be strongest in the early stages.

The views of professionals

According to Tom Lee, co-founder of Fundstrat Global Advisors, 2024 will be a year where the advantages of small-cap stocks will become apparent. He predicts that as inflation declines and the interest rate expected from the Federal Reserve cuts, small-cap stocks will recover from being hit hard by rising borrowing costs. In particular, he stressed that the Russell 2000 index may rise 50% from its current level to reach 3,000 points.

Furthermore, Lee believes that since small companies usually have higher leverage ratios, lower interest rates will have a significant positive impact on them. Furthermore, he pointed out that the current valuation of small-cap stocks, particularly relative to their value on the balance sheet, presents an attractive buying opportunity. As a result, small-cap stocks provide a favorable investment path for investors seeking to take advantage of changes in the market to reap returns.

Coincidentally, Richard Bernstein, chief investment officer of asset management company Richard Bernstein Advisors, is also optimistic about the future of small-cap stocks. He believes that although the rise in the S&P 500 index in 2023 is mainly led by the seven major tech giants, stocks that are currently not receiving much attention will bring high returns in the next ten years.

In response, Bernstein emphasized that the shift in market leadership will provide investors with a “once in a generation” buying opportunity. He predicts that as the global economy recovers and corporate profitability increases, investors will pay more attention to smaller and mid-cap stocks with more attractive prices.

Bernstein predicts that the market capitalization of the seven major US tech giants may shrink by 20% to 25% in the next ten years, while it is very realistic for the Russell 2000 Index to grow by 20% to 25%. His analysis points to a conclusion: neglected and unpopular market segments are breeding huge investment opportunities.

Finally, Morningstar Wealth's analysis of data from the 1970s shows that during a period of accelerated economic growth and slowing inflation, US small-cap stocks performed better than large-cap stocks. The Russell 2000 index had an annualized increase of 25.2%, while the S&P 500 had an annualized increase of 17.3%.

Marta Norton, chief investment officer of Morningstar Wealth America, said that the company increased its holdings of small-cap stocks in its US equity fund, providing a “certain margin of safety” for these stocks due to lower valuations. Compared to large cap stocks, this kind of valuation opportunity has just expanded.

Which sections are worth watching?

Biotech US small-cap stocks are unique in the investment community, mainly due to their innovative potential and flexibility. These companies focus on developing new treatments, drugs, and technologies, and can quickly adapt to changes in the market and science to drive drug development. Revolutionary treatments and medicines, when successful, may bring high returns to investors.

Additionally, small-cap biotech companies are often partners or acquisition targets for larger companies, focusing on specific disease or treatment areas, and utilizing emerging technologies such as gene editing and artificial intelligence. However, these investments also come with high risk because success depends on research results, clinical trials, and regulatory approvals.

At the same time, small-cap stocks in the US materials sector also have unique advantages, including innovation and specialization in high-performance alloys, specialty chemicals, or advanced composites. Their market flexibility allows them to respond quickly to technological advancements and changes in market demand, and they are also often the target of mergers and acquisitions for large enterprises.

Small-cap material science companies can also quickly adapt to emerging market demands, such as renewable energy and biomedicine. Their patents and know-how create competitive barriers in the market. However, these investments also involve risks, and investors need to fully consider market acceptance, technical viability, and macroeconomic impacts before investing.

Which individual stocks are worth watching?

Schudi Biotech (GPCR.US)

Biotech investors all know that there are many opportunities to “step up to the sky” in small-cap stocks, and Schudi Biotech is being favored. Although the small-cap company just went public in February 2023, it has received a “Highly Recommended Buy” rating from many Wall Street analysts. This is a clinical-stage company, which means there are drug candidates undergoing clinical trials, but there are no drugs available for commercial production. Schudi Biotech's main drug candidate GSBR-1290 is an oral GLP-1 receptor agonist used to treat type 2 diabetes and obesity. The company is expected to obtain clinical research data on diabetes in December and obesity research results in January next year. Analysts gave the pharmaceutical stock a target share price of $82.67, which is 155.8% higher than the current share price.

LifeMD (LFMD.US)

LifeMD is a telemedicine company that has received a rating boost from three analysts in the past three months. The company's stock price rose 310% in 2023, and there may be more gains after the rating is raised. LifeMD's revenue grew year by year last year, and the current problem is lack of profitability. That shouldn't change anytime soon, but analysts seem pretty optimistic about the company's outlook. Reasons to be optimistic about this small-cap stock also include a sharp drop in bear interest last month and institutional investors' buying interest last quarter.

Asino Silver & Gold Mines (ASM.US)

Mining stocks are highly cyclical, but sometimes they are significant to investors. In the past three months, a total of four analysts have raised the ratings of Asino Silver & Gold Mines. Investors spent much of 2023 struggling with high inflation and high interest rates. By 2024, these two major negative factors will subside significantly. Another reason to be optimistic about precious metals is that central banks around the world are buying physical gold in large quantities. Wall Street analysts are currently optimistic about the trend of this small-cap precious metals stock, predicting that next year's share price increase may reach up to 263%.

edit/lambor