Historically, US small-cap stocks have had a premium price-to-earnings ratio compared to large caps. Small-cap stocks are currently trading at roughly a 20% discount compared to the long-term average, which presents a compelling forward performance considering the total return, says Lord Abbett.

The investment management firm says that while macro headwinds have cut valuations of small caps, the steep discount may not be warranted.

“From an earnings perspective, we continue to see analysts’ expectations for the earnings of large-cap stocks (based on the Russell 1000 Index) revised downward, while earnings expectations for small caps have remained more resilient,” writes Melanie Coffin, Associate Investment Strategists at Lord Abbett.

Talking about dollar strength, the investment management firm says that most small caps derive revenue from US-related operations, so they are shielded. However, companies that have overseas business may be hurt by the strong dollar as — demand weakens for their goods and services, and currency exchange has a negative impact on profits.

Lord Abbett believes that while small-cap stocks are attractive, inflation and higher interest rates will lead to a difficult operating environment for companies.

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