From Morningstar: 2024-12-03 04:21:18

Small-cap value funds have struggled for over a decade, with 2024 returns at just 12.4%, far behind large growth funds at 28.5%. Only 8 out of nearly 170 US small-cap value funds are beating the US Market Index’s 26.6% return. Despite recent gains, veteran managers see potential for a revival.

Managers attribute small-cap value underperformance to low interest rates, rise of indexing, and global trade expansion. Funds like the James Small Cap Fund have adjusted strategies to include qualitative analysis, momentum metrics, and quality metrics to avoid value traps. PIMCO RAE fund has shifted focus to value stocks as they have become cheaper.

Potential catalysts for small-cap value stock return include deglobalization and inflation, which could benefit small-cap firms. Deglobalization may impact large-cap firms more, while inflation could boost small-cap stocks. Despite challenges, managers are optimistic about potential opportunities in the small-cap value space. Arnott predicts that value stocks will outperform growth stocks by 2%-10% per year when inflation is above 3%. He compares current market conditions to those before the dot-com bubble burst, noting the significant discount of value stocks to growth. Small-cap value stocks performed better during the dot-com bear market, with the US Market Index falling by 19.4% in 2022, while the US Small Value Index dropped by 6.6%.

The election of Donald Trump for a second term as president has been a catalyst for small-cap value stocks. Since the election, the US Market Index has risen by 3.5%, and the US Small Value Index has increased by 5.5%. Small caps saw a significant surge the day after the election, with financials, industrials, and energy sectors performing exceptionally well.

The surge in small-cap stocks post-election mirrors the trend seen in 2016, as investors anticipate policy changes under a new administration. Potential reductions in regulations, extended tax cuts, and trade policies favoring domestic manufacturers are driving the rise in small caps. Large caps, dominated by tech, have seen smaller gains compared to small caps with heavier weightings in industrials and financials.



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