Avoid Large-Cap Stocks: Embrace Small and Mid-Caps for Better Returns

As the market continues to evolve, investors are increasingly turning their attention to small and mid-cap stocks, recognizing the potential for higher returns and growth opportunities. While large-cap stocks have traditionally been the go-to for many investors, the current market conditions and trends suggest that small and mid-cap stocks may be the better choice. Here's why:

1. Monetary Policy and Interest Rates: The U.S. Federal Reserve's pivot to a more dovish stance, potentially leading to an easing of financial conditions, can make it easier for small and mid-cap companies to obtain financing. This can lead to an increase in initial public offerings (IPOs) and a fresh set of opportunities for investors (Source: Capital Group, FactSet, MSCI).
2. Relative Valuations: Small-cap stocks are trading near 20-year lows on a relative basis versus large caps. This means that small-cap stocks are relatively undervalued compared to large-cap stocks, presenting an opportunity for investors to buy into the market at a lower price (Source: Capital Group, FactSet, MSCI).
3. Growing Tailwinds from Global Infrastructure Build: The deteriorating U.S. infrastructure and government willingness to upgrade it, combined with a desire by companies to have better security around supply chains, has brought new life to the industrial complex. This can create opportunities for small and mid-cap companies that supply heating, ventilation, and air conditioning system installation services (HVAC), as well as other industrial goods and services (Source: Capital Group, MSCI, Refinitiv).
4. European Industrial Rollups: European industrials, especially in the Nordic countries, that utilize mergers and acquisitions (M&A) can be true value creators. These companies aim to create value for shareholders through smart capital allocation and growing their business through either vertical or horizontal expansion. This can lead to compelling total returns over longer periods through a combination of dividends, organic growth, and acquired earnings from M&A (Source: Capital Group, MSCI, Refinitiv).
5. Increasing Opportunities in Emerging Markets: Despite lagging large caps in recent years, smaller companies have been an important source of return in global equity markets. They have outpaced their larger brethren close to 70% of the time in rolling three-year periods since 2000. This trend suggests that small and mid-cap stocks can be an important source of return for investors (Source: Capital Group, MSCI, Refinitiv).

In conclusion, the current market conditions and trends make small and mid-cap stocks an attractive investment option. With lower relative valuations, a supportive macro-economic backdrop, and a growing pipeline of IPOs, small and mid-cap stocks offer investors the potential for higher returns and growth opportunities. By embracing small and mid-cap stocks, investors can take advantage of the current market conditions and position themselves for success in the years to come.