After years of being overshadowed by the mega-cap technology giants that have monopolized the market, small-cap stocks are beginning to assert their presence. According to recent insight from Citi, the shift towards small-cap investments is gaining momentum as these companies find their footing in a post-pandemic economy. The Russell 2000 index, which tracks the performance of smaller publicly traded companies, has seen an increase of nearly 11% this year. While this growth still lags behind the S&P 500’s formidable 22% rise, it marks a critical pivot point for investors seeking new opportunities.
Interest Rates and Small-Cap Advantage
One of the primary drivers behind this growing interest in small-cap stocks is the Federal Reserve’s tepid approach to interest rates. As discussions around further rate cuts gain traction, smaller companies—often laden with a higher percentage of floating-rate debt—are poised to gain significant advantages. Lower interest rates mean cheaper borrowing costs, which can translate into improved profitability and, eventually, higher stock valuations for these businesses.
In his analysis, Citi U.S. equity strategist Scott Chronert presents two compelling arguments for small-cap investment: appealing valuations and an expected narrowing in earnings growth between small- and large-cap firms. In essence, investors may find themselves acquiring small-cap stocks that offer similar growth profiles to their larger counterparts at a fraction of the cost. This shift could redefine the landscape of equity investing, allowing room for diversified portfolio strategies.
In its latest note, Citi unveiled a list of high-potential small- and mid-cap stocks with anticipated total returns of at least 10%. Noteworthy among these picks is Abercrombie & Fitch, the lifestyle retailer that has seen its shares surge by 56% this year alone. With Citi projecting a total return of 33%, Abercrombie represents a compelling investment as it capitalizes on revitalized brand momentum across its Hollister and Abercrombie lines. Analysts at JPMorgan have raised their price target significantly, positing a potential upside that remains attractive to bullish investors.
Another exemplary name on Citi’s list is Ally Financial, noted for its steady positioning within the financial services landscape. While up less than 1% thus far in 2023, expected total returns from Ally are projected to be around 48%. Analysts have upgraded the stock on the premise that its current market price incorporates most downside risks associated with credit and earnings over the next two years, positioning it for asymmetric returns that could appeal to risk-sensitive investors.
Citi’s investment focus does not stop with apparel and finance. The entertainment industry offers promising avenues, with TKO Group standing out as an essential player. With nearly 43% growth this year, the firm anticipates a further total return of 19%. This optimism is fueled by expectations surrounding escalating media rights fees as larger tech entities set their sights on sports broadcasting. Analyst Jeffrey Wlodarczak acknowledges that TKO Group has numerous monetization opportunities waiting to be unlocked. His target of $170 reflects a robust upside, making this stock worth following for investors keen on capitalizing on emerging trends in entertainment.
As the small-cap rotation gains velocity, it prompts a reevaluation of investment strategies within the stock market. With appealing valuations, the potential for rising earnings, and supportive macroeconomic factors such as favorable interest rates, small-cap stocks provide an exciting alternative to traditional large-cap investments. Investors now have the opportunity to explore lesser-known companies that may yield significant returns in the coming years. By staying attuned to market shifts and maintaining a diversified portfolio, investors can harness the potential of smaller firms eager to emerge from the shadow of their larger competitors. As the market landscape evolves, so too should our investment strategies, paving the way for future growth opportunities in the small-cap sector.