US small cap stocks led the market forward at the end of 2024, where November was the fourth best month for small cap stocks since 1926. Is this set to continue in 2025?
In this video, Michele Ward, Portfolio Specialist, explores the factors driving this recent momentum, including a robust M&A landscape, attractive valuations, and scope for lesser regulatory burdens under Trump that could favour small caps going forward. However, challenges such as inflation and Fed policy remain, highlighting the ongoing importance of stock selection within the asset class.
Discover how our team is navigating these dynamics to identify the best opportunities for the future.
Small cap stocks have led the market forward ever since mid-October. In fact, November, with nearly double digit returns, was the fourth best month for small cap stocks in the years since 1926. And small cap stocks outpaced their larger counterparts by about 300 plus basis points. So is this a sea change in the life ahead for small cap stocks? Well, we don't know for sure, but Tim Murray, our capital market strategist, recently noted that there are a lot of things that bode favourably for small cap stocks as we look out to 2025. And Matt Mahon, our portfolio manager largely agrees with his points.
Among the biggest positives for small cap stocks is M&A. Since 90% of the acquired companies in the United States have historically been small companies, this is a positive. And 2024 itself has been very strong, with a nearly record number of transactions being consummated. There are economic reasons for that, regardless of what has happened in Washington. Large companies need growth and small companies often provide that.
And their valuations are really attractive relative to their larger counterparts. So this is a good opportunity for a large company to grow. A more benign Federal Trade Commission outlook could make this trend continue for the years to come.
Should the new administration in Washington make good on its proposals for less regulation, that should stand to benefit small companies more than large companies; frankly, because the cost of compliance for them is a bigger burden than it is for their larger counterparts. And finally, small business optimism is ticking up. In fact, the most recent reading shows the biggest jump in over 30 years. That is likely to release some pent up economic demand and maybe fuel growth as we look out into 2025 and beyond.
So in our business, there's no opportunities without risks. And the biggest risks we see today are inflation and the Fed. Inflation is likely to pause on its downward slope or maybe tick back up given the impacts likely to come from both tariffs and any moves on immigration. Now, that said, in the past, inflation hasn't necessarily been as bad an issue for small cap stocks as many investors fear.
In fact, in the 1970s, which was the most inflationary period in recent memory, small cap stocks were the leader in the market. In addition, though, the Fed is likely to take a more cautious tone to its upcoming program of interest rate moves. The market's already anticipating fewer cuts than they did previously. If you're a company in need of refinancing, that is going to be an issue. However, our portfolio generally has better balance sheets, less of that refinancing risk. So we feel relatively good about our portfolio, but a little more sceptical about the broad impact on small cap stocks.
This highlights the importance of being selective in small cap investing. It's always important, but probably never more so than it will be in 2025 and beyond. Trump 2.0 is not likely to be a direct reprise of Trump 1.0. So we are thinking very carefully about the opportunities and the consequences or risks outstanding. And Matt’s working alongside the analysts to find the best ideas, looking out 3 to 5 years, as we always do
We're looking forward to talking to you more about that in the months to come.
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