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Small-cap shares poised to benefit from shift to value

Wall Street Week ahead

Small-cap shares poised to benefit from shift to value

Business Desk Beleaguered shares of small US companies are set for a bump in performance as value stocks have risen, market analysts say, but small caps could quickly fade again with an economic setback. The small-cap Russell 2000 index has lagged the benchmark S&P 500 .SPX for much of 2019 and has yet to escape the bear market it confirmed last December. Still, so far this quarter, the Russell 2000 has risen 4.6 per cent, edging out the 3.6 per cent rise in the S&P 500. The Russell’s outperformance is in tandem with the S&P 500 Value index, whose 5.2 per cent quarter-to-date climb has outpaced the S&P 500 Growth index’s .IGX 2.3 per cent advance over the same period. Improving economic sentiment has prompted some investors to take a second look at undeperformers among both value stocks and small-cap shares. Value shares tend to be concentrated in economically sensitive sectors such as financials and energy. Shares of small-cap companies, which tend to be more domestically focused than their large-cap counterparts, often track investors’ outlook on the US economy. Reflecting growing economic optimism, the benchmark 10-year Treasury yield has moved well off its early September lows, and the yield curve between 3-month bills and 10-year notes has steepened. As a result, some investors believe US small-cap stocks are set to rally. The performance of financial shares, in particular, has improved as yields have risen, which could help boost small-cap shares. Financials make up 20 per cent of the Russell 2000, as compared to 13 per cent of the S&P 500. “Higher rates tell us that you’ve got a stronger economy,” said Gary Bradshaw, senior vice president and portfolio manager at Hodges Capital Management in Dallas. “Small caps, which have lagged the large caps, can certainly catch up (given) this rotation into value.” In recent months, Bradshaw said, Hodges has added positions in small-cap value companies such as oil and natural gas companies Matador Resources Co and Parsley Energy Inc as well as Brinker International Inc, which owns Chili’s restaurants. Though some market analysts are skeptical that large-cap value shares will sustain their market leadership, the improving earnings backdrop for small-cap companies could nonetheless boost their shares. Earlier this year, the earnings growth rate for small-cap companies lagged that of large-cap companies, in an aberration from usual patterns, said Lori Calvasina, head of US equity strategy at RBC Capital Markets in New York. But since then, small-cap earnings growth has recovered. “People like small caps because they offer superior earnings growth longer-term,” she said. “You couldn’t really say that based on these stats at the beginning of the year, but now we look at these stats and the normal relationship is returning.” Still, the outlook for small-cap shares is highly dependent on US economic data, which suggest a slowdown. The Institute of Supply Management’s widely followed manufacturing index, for instance, has indicated a contraction in US factory activity for three straight months. A US-China trade agreement would help bolster economic indicators in the manufacturing and industrial sectors, but it remains tentative. Data on October US industrial production and retail sales, along with the National Federation of Independent Business’s monthly small business survey, are scheduled for release next week. “If we don’t get a deal on trade, if we get more indications that the US economy is weaker, small caps are going to get crushed,” said Steven DeSanctis, equity strategist at Jefferies in New York. “But I see (economic) growth holding up.” Earlier on Friday, the three major US stock indexes posted record closing highs and the S&P 500 registered a fifth straight week of gains on Friday as investors brushed aside worries over the progress of US-China trade talks and as Walt Disney shares rose. Doubts about trade progress resurfaced earlier in the day when President Donald Trump, in remarks to reporters at the White House, said he has not agreed to a rollback of US tariffs sought by China. On Thursday, officials from both countries said that the United States and China had agreed to such a deal. Tim Ghriskey, chief investment strategist at Inverness Counsel in New York, said that while the market was initially volatile because of Trump’s remarks, it climbed right back. “The feeling now is that before the end of the year we’re going to see some type of deal,” Ghriskey said, even if it is a partial one. The Cboe volatility index posted its lowest closing level since July 24. Helping to boost the S&P 500, Walt Disney Co gained 3.8 per cent a day after it reported quarterly results that showed it spent less than it had projected on its online streaming service, Disney+. Disney’s popular theme parks and a remake of “The Lion King” lifted earnings. The Dow Jones Industrial Average rose 6.44 points, or 0.02 per cent, to 27,681.24, the S&P 500 gained 7.9 points, or 0.26 per cent, to 3,093.08 and the Nasdaq Composite added 40.80 points, or 0.48 per cent, to 8,475.31. For the week, the S&P 500 rose 0.8 per cent, posting a fifth straight week of gains, while the Nasdaq gained 1.1 per cent, closing out its sixth straight week of gains. The Dow was up 1.2 per cent for the week. Increasing optimism on the trade front and mostly better-than-expected earnings have driven the recent record run in stocks. Of the 446 S&P 500 companies that have reported results so far, roughly three-quarters have beaten profit estimates, according to IBES data from Refinitiv. The numbers, to some extent, reflect significantly lowered analysts’ forecasts. Technology shares also supported the market, including Microsoft, which rose 1.2 per cent. Among decliners on Friday, shares of Gap Inc fell 7.6 per cent after the apparel retailer said Chief Executive Officer Art Peck would leave the company, a surprise exit in the middle of a restructuring. Gap also slashed its full-year earnings forecast. Advancing issues outnumbered declining ones on the NYSE by a 1.07-to-1 ratio; on Nasdaq, a 1.13-to-1 ratio favored advancers. The S&P 500 posted 29 new 52-week highs and two new lows; the Nasdaq Composite recorded 74 new highs and 87 new lows. Volume on US exchanges was 6.59 billion shares, compared with the 6.79 billion-share average for the full session over the last 20 trading days.

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