Below-average valuations and underperformance that have lasted for years: what area of the stock market are we talking about? Medium/small companies, that is, with market capitalizations typically below 2-3 billion euros, which now seem like peanuts compared to the 3000 billion reached by some American megacaps.
If we look at historical data with reference to the United States, where the track record is very long-term, we see that the performance of these companies has been underperforming compared to the rest of the market (to the S&P500 to be clear) from 2017 onwards; if we look at Europe we find a similar situation over a period of just 3 years (the Kepler Chevreux graph shows you this well).
This underperformance is not normal since medium/small companies are typically higher growth, expose the investor to a slightly higher risk and therefore must provide a higher return in the long term.
If we take the data from Bloomberg relating to the MSCI world small cap, mid cap and entire market (therefore big cap) indices, this is fully confirmed: small companies over a 25-year time frame have returned an average annual 9.2% (total return data), midcaps 7.4% and big companies just over 7%.
The last few years are therefore an anomaly and the current situation could be a good time to invest in this area. Those who have done so in recent years have suffered a lot, but the future should be significantly better, at least that’s what the past tells us.
The rise in interest rates has been one of the main factors in negatively influencing the performance of medium/small companies: there is a strong inverse relationship between the relative performance of small and mid caps and nominal and real rates (see the Goldman Sachs chart referring to the USA). The last 3 years have led to a worsening of the economic accounts since the average debt of these companies is higher.
The lower growth of economies is another penalizing factor; these companies can do very well when countries grow well and the last 5 years have been less brilliant with lower average growth and in addition a high uncertainty and little visibility related to Covid and post Covid and now to wars.
The third and final critical factor was the exceptionally good market performance of big and mega caps: this phenomenon, now well known, is particularly pronounced in the US (Magnificent7 & co), but is also seen in Europe. Never in the past have we seen market indices, such as the S&P500, with such a high weight of the top 10 companies (we are close to 35%) and so driven by them. The Morgan Stanley graph showing how little small caps weigh today on the overall capitalization of the US stock market (2.5% compared to an average of 7.5%) is eloquent.
The end result is a significant misalignment between the relative valuations of small and mid caps and big/mega caps that is substantially true across all geographies, although most pronounced in the US.
These three unfavorable phenomena for the world of small and medium-sized enterprises will evolve in the coming quarters and therefore it seems right to dedicate part of one’s equity investments to this area.
In this regard, it is useful to underline how in the last few days (second trading week of July) we have had an important signal on the market side with a high outperformance of American small caps compared to the rest of the market (S&P100 index in this case therefore big and mega caps). The +9.55% recorded represents the greatest outperformance of the last 50 years. It is early to say that the trend reversal has begun and that a favorable period for small and medium-sized companies has begun, but it is a very encouraging signal.
Even in Italy, the relaunch of investments in Italian companies that many have hoped for, perhaps together with a review of the regulations on PIR (individual savings plans), which are very focused on small and medium capitalizations, could lead to more favorable years on the market.
The stock market performance of Italian small and mid caps has always been good and in the long term has given higher returns than the traditional index made by larger companies. The Ftse Italia STAR Index of Borsa Italiana / Euronext is a good example in this sense. This is the current composition.
