Since the beginning of the year, the risk-off environment for equities has hit small-cap equities harder than large caps. Global risk-off has been driven by twin threats of higher global interest rates compounded by the outbreak of conflict in Russia/Ukraine. In Australia, the relative underperformance of the Small Cap index vs the large-cap index is around 10% this year. A similar trend is evident in the US where the Russel 2000 has underperformed the S&P 500 by ~7% since November 2000.
In historical terms, this level of underperformance by small caps in a risk-off environment is relatively modest both in terms of magnitude and time. We can point to four episodes during the last 20 years where underperformance is greater than 20%. In three of these periods, the underperformance lasted >18 months. Only in the March 2020 black swan event of COVID did the underperformance last for less than 6 months.
We continue to hold a constructive view around the Australian outlook, particularly relative to the rest of the world. On a valuation basis, small cap PER multiples have compressed almost 20% since the peak in 2020 and now sit in line with the 5-year average. This suggests Australian small caps are now approaching an oversold level.
With several macro risks lifting in the last week, the Federal Reserve meeting, and a possible pathway for peace in Ukraine, the risk-off discount in Australian small caps is vulnerable to snap-back.
Consumer tax relief in next week’s Federal Budget, potentially via lower petrol prices, could provide additional impetus for the discount to close.
Inside we highlight several small-cap opportunities from our Wilsons Equity research team and additional names from our Investment Strategy team.
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Written by
John Lockton , Australian Equities
John is a leading investment strategist with 20 years experience.