Is Now the Time for Small Cap Growth to Shine?


Across US indexes, growth has experienced a resurgence relative to value off the June 17, 2022 low. In this piece, I am going to focus on small-cap stocks and consider their merits through the lens of: 1) US Treasury yields, 2) oil prices, and 3) ISM Manufacturing.

In the chart below, I compared the S&P 600 Value Index relative to the S&P 600 Growth Index alongside the 10-year US Treasury yield. In short, value outperforms growth when rates are falling and outperforms when rates are rising. With 10-year US Treasury yields having just broken the neckline in a head-and-shoulders top formation, it would appear the direction of travel for rates is down. This would suggest a preference for growth over value.

The picture is very similar when we look at the S&P 600 Value/Growth ratio compared to oil prices. Historically, when oil is rising, value outperforms, and when it is falling, growth outperforms. Yesterday, West Texas intermediate oil broke down through its 200-day moving average, often considered a sell signal for traders. As of this writing, oil is down about 3.5%, so we appear to be getting technical confirmation of the peak in oil prices.

Last, I consider small-cap value vs. growth through the lens of ISM Manufacturing—a proxy for economic activity. When activity is contracting—when the ISM is falling—value tends to underperform growth, and when activity is expanding, value tends to outperform growth. The ISM peaked in March 2021 and has been slowly sinking since then. Through this lens the outperformance of value over growth all year seems anomalous. Now, growth is playing catch up, trying to resynch with a persistently falling ISM.

So, in summary, when considering the backdrop when small-cap value outperforms:

  • 1. Interest rates are rising,
  • 2. Oil prices are rising, and
  • 3. Economic activity is expanding.

At present, none of these conditions seem to be prevail, so it would follow that investors looking for small-cap exposure should focus on the growth part of the index rather than the value part.

 

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Image and article originally from www.knowledgeleaderscapital.com. Read the original article here.