The performance of the US equity market over the last decade has been dominated by a small number of highly valued mega-cap companies. This phenomenon has spurred a noteworthy concentration among top-tier players. However, in the current landscape, T. Rowe Price maintains a positive outlook for US small-cap stocks.

“…we believe company valuations at the smaller end of the scale are at their most compelling levels in decades. This is creating opportunities to add exposure to high‑quality, growth‑oriented businesses with the potential to compound returns over time,” writes Curt J. Organt, Portfolio Manager at T. Rowe Price. 

Organt draws upon historical data to suggest that when concentration at the top unwinds, a cycle of small-cap outperformance often follows, creating room for attractively valued smaller stocks to shine. Subsequently, he notes that US small-cap stocks have traditionally traded at a premium due to risk-return profiles, but this valuation recently flipped, causing small-cap stocks to trade at historic discounts.

On macroeconomic trends affecting the asset class, T. Rowe Price states: “Smaller companies are more domestically oriented, and so, better positioned to benefit from shifting trends in the US economy. Notably, consumer spending in the US is moving from goods to services, a trend that is likely to be particularly supportive of smaller‑company earnings.” 

Also, as per the asset manager, rising US capital spending (capex) and initiatives to reshore supply chains provide tailwinds for US small-cap stocks. Nonetheless, Organt underscores the necessity for prudence even amid optimism, attributed to the upsurge in “zombie stocks” – companies incapable of servicing debt interest, signifying a decline in quality.

In conclusion, the asset manager says: “The ‘smaller companies’ segment will remain sensitive to the vagaries of the economy and to market sentiment, making an active approach essential in navigating a way forward, but the current weight of evidence suggests a positive long‑term outlook for US smaller companies. It’s no time to wait on the sidelines.” 

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