Preview
In focus: Brighter outlook for undervalued small caps
Small-capitalization (small-cap) stocks may be entering a more favorable environment in the second half of 2024 and beyond. With their valuations already at the lowest levels versus big caps since the early 2000s, small caps may benefit from the potential start of the interest-rate easing cycle in the United States and Europe. Fundamentally, small caps may see accelerated earnings growth amid a resilient global economy, while merger and acquisition (M&A) activities may provide another positive catalyst.
Investment outlook
In North America, the environment for stockpickers has not been ideal, as a handful of names have made up the bulk of the market’s performance. Limited exposure to rallying US mega-cap tech stocks continued to be a major headwind for our global equity strategies. We do not own many of these stocks based on valuation grounds. However, we do have exposure to the AI theme through investments in semiconductor companies that are integral to the development of AI.
In Asia Pacific, July markets were volatile as investors digested corporate earnings, the evolving interest rate outlook and geopolitical news flow. We see the same uncertainties potentially affecting the Asian market in the second half (2H) of 2024, even as regional earnings are on the cusp of recovery. In Asia, market consensus is calling for an 11% second-quarter earnings growth in Asia ex Japan, 4% in Japan and 9% in China.1 While these growth numbers reflect in part the low base in 2023, regional earnings appear to be bottoming out. For the full year of 2024, earnings appear likely to grow 27% in Asia ex Japan, up from the 4% decline in 2023.2
In Europe, the opportunity set we identified at the end of 2023 and the first quarter (1Q) of 2024 remains largely unchanged: SMID companies, UK investments, relative value in staples/utilities, some verticals of undervalued cyclicals (including real estate, construction and IT services). In our view, many of these pockets should be beneficiaries of declining interest rates.
Market review: July 2024
Global equities collectively rose in July 2024. As measured by MSCI indexes in US-dollar terms, developed and frontier market equities outpaced the global MSCI ACWI benchmark, while emerging market equities trailed it. Global value stocks significantly outperformed global growth stocks, which generally declined.
Stocks gained in July despite heightened volatility that included a rotation away from large-cap technology-related stocks worldwide—especially those focused on AI. Cooler-than-expected inflation and a softening job market in the United States increased investor expectations for interest-rate cuts, leading to a preference for small-cap stocks, rate-sensitive equities and more cyclical areas of the market. Global manufacturing activity contracted in July for the first time in 2024, while flash reports for July indicated services activity expanded across regions.
Endnotes
- 1. Source: Société Générale, “Asia Equity Strategy.” July 24, 2024. There is no assurance that any estimate, forecast or projection will be realized.
- 2. Ibid.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal. Small- and mid-cap stocks involve greater risks and volatility than large-cap stocks. There can be no assurance that multi-factor stock selection process will enhance performance. Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods.
Active management does not ensure gains or protect against market declines.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Investments in companies in a specific country or region may experience greater volatility than those that are more broadly diversified geographically. The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries. There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact the fund. Investments in Taiwan could be adversely affected by its political and economic relationship with China.
Investments in fast-growing industries like the technology sector (which historically has been volatile) could result in increased price fluctuation, especially over the short term, due to the rapid pace of product change and development and changes in government regulation of companies emphasizing scientific or technological advancement or regulatory approval for new drugs and medical instruments.