Smaller Cap Stocks Poised for Global Outperformance, JPMorgan's Lecubarri Says

Smaller cap stocks have been underperforming their larger counterparts for some time, but a shift in market dynamics may be on the horizon. Eduardo Lecubarri, global head of small and mid-cap equity strategy at JPMorgan (JPM), believes that smaller cap stocks are set to outperform globally. This article explores the reasons behind this potential shift and the implications for investors.

The underperformance of smaller cap stocks can be attributed to several factors, including cyclical headwinds and structural challenges. Cyclically, smaller firms are more vulnerable to interest rate hikes, with a higher proportion of floating-rate debt and shorter maturities. Structurally, the decline in quality of small cap indices, with a higher share of unprofitable firms, and a less favorable sector mix contribute to their lower valuations.

However, as cyclical headwinds fade, smaller cap stocks could rerate from currently depressed valuations. Buying small caps during recessions has historically been a winning strategy, as the likelihood of central bank rate cuts and prospects of an economic recovery boost smaller firms over their larger counterparts. Over the three years following the start of a recession, the Russell 2000 has outperformed the S&P 500 by an average of 22 percentage points.



In addition to cyclical factors, smaller cap companies have several inherent advantages that could drive their outperformance. Many smaller cap companies are at the leading edge of innovation, developing breakthrough software or advances in industrial automation. This innovation, coupled with streamlined business models and embedded competitive advantages, makes smaller cap companies ideal targets for M&A activity. As a result, JPMorgan's 2024 Long-Term Capital Market Assumptions estimate robust returns for U.S. SMID-cap equity over a 10-to-15-year investment horizon, even rivalling that of U.S. large caps.

Investors looking to capitalize on the potential outperformance of smaller cap stocks should focus on high-quality companies with strong earnings growth, attractive valuations, and growing competitive advantages. By evaluating these factors, investors can mitigate risks and maximize potential returns from smaller cap stocks.

In conclusion, smaller cap stocks are poised for global outperformance as cyclical headwinds fade and their inherent advantages become more apparent. Investors should consider allocating a portion of their portfolios to smaller cap stocks to benefit from this potential shift in market dynamics. However, it is essential to remain vigilant and adaptable, as market conditions can change rapidly, and risks should be carefully managed.