Why US small-cap stocks are ideal for long-term investing

In 2023, US small-cap stocks faced challenges despite starting the year with low valuations. However, for the new year, the country’s small cap offerings appear compelling for several reasons, opines American Century Investments.  

The asset manager points out that US small-cap stocks are currently under-owned and have favourable valuations. Additionally, the fundamentals of small-cap companies can potentially gain from the ongoing trend of relocating manufacturing operations back to the United States, writes Mike Rode, VP Investment Director at American Century Investments. 

“This shift is driven by geopolitical risks, dwindling cost advantages, and fiscal stimulus programs like the U.S. CHIPS Act and Inflation Reduction Act,” he adds. 

Subsequently, the asset manager informs that in a recessionary environment, US small-cap stocks have historically underperformed initially but tend to lead all asset classes out of a recession. Separately, Rode contends that with 27% of US small-cap companies being unprofitable, active management is recommended to navigate potential winners and losers.

Regional banks, constituting a significant portion of the US small-cap stocks universe, faced challenges in 2023. However, the American Century Small Cap Value team sees an opportunity, considering attractive valuations and perceived quality improvements in the sector.

“…we believe the quality of select institutions is better than many perceive…Although current profitability faces challenges, we expect improvement in the second half of 2024,” asserts American Century Investments. 

The asset manager also says that while companies are staying private longer, there are still over 1,500 publicly traded small-cap options. Furthermore, as per the asset manager, the IPO market in the US is expected to rebound when market conditions are favourable.

Besides, the asset manager believes that small-cap performance historically benefits from inflation rates of 2%-4%. “A resurgence in inflation from these levels and a resumption of Federal Reserve interest rate hikes would challenge small-cap performance relative to large-cap companies,” says Rode. Despite this, compelling valuations provide a solid foundation for patient, long-term investors. believes American Century Investments. 

Read the full Insight here.