Why 2021 Could Be The Year Of The Small-Cap

Dear Reader,
Analysts have been calling it for months – as the economic standstill and market turmoil caused by COVID-19 has dragged on throughout 2020, the silver lining on the horizon was that economic recovery would begin at some point, and when it did, small-caps would be in favour with investors again, offering new opportunities to make big gains.

Why? Because historically, small-caps have typically outperformed during the period immediately following an economic downturn, often beating the performance of large caps.

The announcement of the development of several potentially viable vaccines during November, as well as a calmer than expected US presidential election, and both the Democrat and Republican sides of a split Congress agreeing to initiate another stimulus package before year’s end signaled to many investors that there is light at the end of the tunnel that has been 2020.

Small-caps are hot, hot, hot

Market activity since November has certainly reflected the theory that a hint of future economic recovery means it’s time to rotate into small-caps. The Russell 2000 index of small-cap stocks have recovered and then some from its COVID-19 induced lows, gaining over 80% since March. In November, the Russell 2000 gained 18.29%, its best performing month since its inception in 1984. And on Friday (Dec 4th), it reached an all-time high of 1,892.45.

Earlier this week, Jefferies’ small- and mid-cap strategist Steven DeSanctis said in a note to clients that he predicts the Russell 2000 will rise 12.5% to reach 2050 next year, one of the most bullish forecasts his team has had for small-caps since 2003. DeSanctis estimates that small-caps will beat large caps by 6.4% in 2021, with a weakened US Dollar aiding the performance of small-caps, and opening the door to increased M&A activity throughout the year. Jefferies forecasts small-cap earnings to grow 40% in 2021.

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DeSanctis also added that because of November’s rally, he expects there to be a pull-back in small-caps in the near-term of between 5% and 10% before momentum picks up again in 2021.

Make hay while the sun shines, but use discipline

It’s important to note however that while general market sentiment seems to reflect an attitude that economic recovery is almost certainly here, in reality, it might be some time before this is actually the case. By “recovery”, what analysts are referring to is an improvement in the macro conditions that can allow the economy to start moving forward again, after the pandemic-induced slowdown.

There are still risks that can threaten this recovery – one being the ability of countries to obtain and distribute the vaccines quickly enough, and another being the long-term effects of fiscal and monetary stimulus that has been ongoing throughout the pandemic.

Deutsche Bank noted in its report “Hope on the Horizon”, published at the end of November that despite upgrading its global growth outlook for 2021 on the back of the recent vaccine announcements, the bank believes the full impact of looser fiscal stimulus policies in response to the pandemic may not become apparent until later:

“We see an increasing risk of financial disruption down the road stemming from the growing overvaluation of assets and mounting debt levels driven by the necessary extremes to which monetary and fiscal policy stimulus have moved,” the report said.

“Financial crises have often been touched off in the past under such conditions by the inevitable shift from policy ease to policy tightening, which is likely still at least several years away, but could surprise sooner.”

Our advice is to do your homework – look for opportunities in small-caps, but make sure you don’t get too comfortable in what could be a very hot market. There are always gains that can be made during both bear and bull markets – especially in small-caps – the important thing is to keep educating yourself on what makes a high-quality company regardless of market conditions.

We’ll be keeping you up to date on developing market trends and investment ideas in the coming months, so stay tuned.
Wishing you many happy returns,

Dear Retail Editorial Team
Dear Retail Investors

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