Managers have begun shifting away from US small caps to their larger peers as sluggish growth and tighter policy in the world’s largest economy weighs down on sentiment.
Key indicators suggest a decline in fortunes for small-cap stocks in the country, with both sentiment and benchmarks appearing to falter.
America’s NFIB Small Business Optimism index – which reflects sentiment in this area – is currently at 93.8, below the figure of 94.6 this time last year.
Meanwhile, the Russell 2000 index, consisting of US small- and mid-cap companies, has struggled to make gains since the end of 2013.
A number of managers are becoming more wary of small caps and are citing signs of a divergence in sentiment between them and their larger peers.
Fidelity Solutions portfolio manager Nick Peters said: “Small caps are typically more reliant on bank lending than their large-cap counterparts, and so interest rate rises tend to have a greater impact on profitability – and the ability of small caps to finance growth.
“While small caps are generally trading in line with large caps from a valuation perspective, the low-growth environment makes it harder to generate exciting levels of growth, one of the key benefits in investing in smaller companies for investors.”
Patrick Close, co-manager of Neptune’s US Opportunities fund, said the dip in US small-cap performance began when the market reacted to the possibility of the US Federal Reserve tightening policy.
“From that early to mid-2014 time frame when small caps started to underperform large caps, that coincided noticeably with a change in global financial conditions,” he explained.
“As the Federal Reserve was tapering quantitative easing and started to move more towards a footing of interest rate rises, that’s when you started to see this underperformance begin.”
The Neptune fund currently allocates around 10 per cent to US small- and mid-cap companies, a neutral position.
In contrast, the S&P 500 index has been on a bull run.
On a one-year basis the S&P 500 has gained 8.9 per cent, dwarfing the 0.9 per cent rise in the Russell 2000 index, data from FE Analytics shows.
Some managers believe the sense of security investors feel regarding large, established companies has driven this, as sluggish global growth and volatile markets have many looking for a safe place to store cash.
Kirill Pyshkin, US and global equities fund manager at Mirabaud, said: “Large caps are more defensive so it is natural to prefer [those] when volatility is rising as it is today.
“Large caps outperformed in the sell-off earlier this year, hence you should overweight large caps if we are heading into a sell-off.”
But some commentators believe this could be a signal of difficulties likely to spread overseas.
AJ Bell investment director Russ Mould said: “The loss of momentum evident over the past 12 months or so, despite record low interest rates and highly accommodative monetary policy, is of great concern, especially as the UK’s indices tend to follow the lead they get from their American cousins.”
KEY NUMBERS
8.9%: Increase in the S&P 500 index in the past 12 months
0.9%: One-year gain in the Russell 2000 index
