Highs and lows: the valuation question

Highs and lows: the valuation question

Concerns about elevated valuations across nearly all markets have increasingly accompanied the economic recovery from the COVID-19 crisis. How worried about this issue should investors be when gauging the likelihood of small-caps’ continued outperformance?

“It’s difficult to assess what the consensus is in this current environment, and it’s also difficult to understand which costs will remain and which will go away,” Juan Hartsfield, Growth Small Cap Senior Portfolio Manager, told the webinar. “But if we look at this from a standpoint of individual stocks, within our investment style, we’re still finding stocks with very compelling valuation upside.”

Figure 1 charts the liquidity differential between small-cap and large-cap evaluations since the mid-1990s. As Hartsfield pointed out, the situation today echoes that at the turn of the century – when small-caps went on to hold sway over large-caps for an extended period. 

“We’re at a point now where we’ve not been since the early 2000s, and on that occasion it marked the start of a really strong small-cap rally,” Hartsfield told the webinar. “Maybe in the short term we could see small-caps tread water, simply because their outperformance since March 2020 has been so rapid. Structurally, though, there’s an argument for thinking they could do well relative to large-caps in the years to come.”

Robin West, UK Small Cap Fund Manager, acknowledged the need for prudence in some instances. “We’re cautious about some of the very highly rated stocks,” he said. “That’s especially the case where valuation is predicated on discounting at very low rates in an environment where interest rates may rise.”

Meanwhile, at the other end of the scale, good value could still be found in many pandemic-hit stocks, said West. “We think many of these companies have solid recovery potential and can come out of this with their market positions enhanced,” he told the webinar. “We’re seeing increasing earnings upgrades, which should also help drive the market.”

Figure 1: Small-caps versus large-caps – relative pricing
Figure 1: Small-caps versus large-caps – relative pricing
Source: Credit Suisse HOLT Lens, as at 22 April 2021.

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