Smaller-company stocks offer better value than those of major corporations this year as the U.S. dollar becomes more valuable than foreign currencies, according to Credit Suisse.
The Swiss bank said its financial model for the Standard & Poor’s 500 Stock Index indicates the biggest publicly traded companies have gotten more expensive than the 30-year average. The move typically means that the index will drop by 6 percent in the following 12 months.
“The case for large caps continues to deteriorate while the case for small caps continues to strengthen,” Lori Calvasina, a New York-based analyst for Credit Suisse,
said in a March 4 report obtained by Newsmax Finance. “We suspect that the strengthening of the U.S. dollar bears much of the blame for the recent deterioration.”
The
dollar this week rose to a 11-year high compared with a group of foreign currencies as investors saw a greater likelihood that the Federal Reserve will raise interest rates this year. A rate hike will make dollars scarcer just as other regions including Europe and Asia are printing more money to stimulate economic growth.
A more expensive dollar makes U.S. products more expensive to foreign buyers and reduces the value of U.S. company sales in those countries. Smaller companies typically are more insulated to currency changes because they don’t depend on foreign sales as much as larger corporations do.
Credit Suisse said that small-cap stocks, which have a median market value of about $1.5 billion, have also gotten more expensive “but valuations have improved over the past year and do not look nearly as stretched as those for large caps.”
The bank’s valuation model indicates the small-caps will rise by 2 percent in the next 12 months. The S&P 500 has risen about 10.5 percent in the 12-month period through Monday, compared with a 1.3 percent gain for the Russell 2000 index of small-cap stocks.
“Small caps are currently the cheapest they’ve been relative to large caps since the end of the tech bubble,” Calvasina said. “Now is the time for those who have been cautious on small-cap from an asset allocation perspective to start tiptoeing back in, and to trim their large-cap exposure.”
Individual investors should allocate money to small-cap stocks through a mutual fund or exchange-traded fund, according to financial adviser Paul A. Merriman.
It's not hard to understand why small companies can make good investments: They have lots of room to grow,”
he wrote on the MarketWatch website. “Google was once a startup, as was Apple. The same is true for every corporate giant.”
He cited historical data that show U.S. small-cap stocks had a compound annual return of 12.2 percent from 1928 to 2014, compared with 9.8 percent for the S&P 500.The major drawback to small-caps is that they are more volatile than large-cap stocks.
“On the way to that fine long-term performance, small-cap stocks gave investors a bumpier ride,” Merriman said. “Although the average one-year return for this asset class was 16 percent, there was one year (1933) when small-cap stocks more than doubled (up 110 percent) and another when they lost 48 percent (1937).”
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