The global rally in smaller-capitalized shares is not worth chasing, according to the world’s largest money manager.
A late-cycle environment of slowing growth and rising uncertainty means investors should avoid smaller companies which tend to be more sensitive to changes in economic activity, BlackRock Inc. strategists, including Richard Turnill, wrote in a note to clients Monday.
“Small cap stocks are on a tear, yet we advise caution on chasing the rally and favor higher-quality large cap shares,” they said. “We see fewer catalysts for sustained small cap outperformance ahead.”
A dovish turn by central banks led by the Federal Reserve, and optimism over U.S.-China trade talks have helped risk assets across the world recover from the late-2018 sell-off. In equities, smaller companies have led the way with the MSCI World Small Cap Index up about 13 percent, compared with a 10 percent rise in it’s large-cap counterpart.
A tendency to have higher operational leverage, a less diversified business and greater reliance on floating-rate debt leaves smaller-capitalized firms less resilient during periods of decelerating growth, according to BlackRock. They have on average thinner margins and riskier debt profiles than larger firms, making them more vulnerable to earnings downgrades, the strategists said.
“We advocate building portfolio resilience through high quality exposures and caution toward lower-quality market segments, such as small caps,” they wrote. “We favor large caps for their stronger balance sheets, more diverse businesses and greater operational flexibility.”
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