Undervalued stocks of smaller companies are experiencing a much-awaited resurgence, highlighting the newfound optimism on Wall Street. The S&P 600 small-cap index has rebounded by approximately 8% since hitting its low point in May, signaling a potential winning month, which would be the first since January.
Small-cap or undervalued stocks serve as significant indicators of the domestic market, as these companies primarily generate revenue from US customers. They also have considerable exposure to financial stocks.
While these stocks have stabilized since the banking turmoil earlier this year, their sustained stability is crucial for a continuous market rally, as strong banks are indicative of a healthy economy.
According to investors, the recent gains in small-cap stocks are contributing to the ongoing bull market, even amid concerns of an impending economic downturn. This is partly because they have helped broaden the previously narrow rally led mainly by mega-cap tech stocks, which have reached extraordinary heights due to the race in artificial intelligence and a flight to safety on Wall Street.
The rebound of small-cap stocks marks a significant turnaround from their earlier decline this year, which was triggered by the collapses of Silicon Valley Bank, Signature Bank, and later First Republic Bank, leading to a sell-off in financial stocks. The current rally in small caps reflects Wall Street’s optimism regarding the overall health of the economy. Some investors believe that the combination of attractive valuations and expectations of a relatively subdued economic downturn make small caps more appealing than they have been in months.
According to FactSet, the S&P 600 is currently trading at approximately 13.53 times its projected earnings, below its 10-year average of 15.89. In contrast, the S&P 500, consisting of large-cap stocks, is trading at multiples of 19, exceeding its 10-year average of 17.61. This indicates that small caps are historically inexpensive, especially when compared to their larger counterparts.
