Unlocking Small Cap Potential in the AI-Tech Rally

Unlocking Small Cap Potential in the AI-Tech Rally

Table of Contents

  1. Introduction
  2. Small Cap Run-Up
  3. Market Melt and Broadening Trend
  4. Cautiousness on AI Names
  5. Small Cap Valuation and Economic Cycle
  6. Cautiousness on Frothy Positions
  7. Trimming Staples Stocks
  8. Areas of Interest: Small Caps, Industrials, and Semis
  9. Investing Strategies Ahead of the Fed Meeting
  10. Expectations on Profits for 2023

Article

Introduction

In this article, we will Delve into the latest market trends and strategies discussed by Ellen Hayes, the FL Putnam Chief Market Strategist. Our main focus will be on the small cap run-up and the caution surrounding AI names. Furthermore, we will explore the valuations of small caps, discuss the economic cycle, and analyze the trimming of frothy positions and staples stocks. Additionally, we will touch upon areas of interest, such as small caps, industrials, and semis, and examine investing strategies ahead of the upcoming Fed meeting. Lastly, we will consider the expectations for profits in 2023.

Small Cap Run-Up

The small cap segment has garnered significant Attention recently as it shows signs of potential growth. Despite the dominance of large-cap tech companies, small caps have also started to bear watching. Ellen Hayes mentions that FL Putnam has been gradually increasing their exposure to small caps in recent months. One notable aspect is that small caps currently trade at a six-point discount to large caps Based on price-to-earnings ratios. This discount appears to be at its largest, making small caps an interesting prospect.

Market Melt and Broadening Trend

The market has been experiencing a phenomenon known as the "market melt." This refers to a broadening beyond big tech and AI-focused businesses. According to Ellen Hayes, only 25 percent of S&P names have outperformed year to date. This narrowing of market moves has led to some caution regarding AI names that have run too fast. While companies like Microsoft and Nvidia are considered great with phenomenal leadership in the AI space, their multiples have expanded significantly. This raises concerns about chasing these stocks at their Current levels.

Cautiousness on AI Names

FL Putnam's cautiousness on AI names Stems from the market's overall narrowness. Ellen Hayes acknowledges that some high-quality AI names may be worth owning but suggests trimming positions when multiples have expanded excessively based on hype. The current market frenzy surrounding AI raises concerns about potential disappointments and stock volatility. Although it is uncertain whether We Are at peak AI frenzy, it is advisable to exercise caution and consider purchasing these names on pullbacks.

Small Cap Valuation and Economic Cycle

Small caps typically perform well at the beginning of an economic cycle. FL Putnam believes that if a slowdown occurs over the next couple of quarters, followed by a market and economic re-acceleration, small caps could experience significant growth. Moreover, the valuation support that small caps provide adds to their attractiveness as an investment option. While there is still uncertainty about whether recent positive performance is a head fake or sustainable, the valuation support makes a strong case for owning U.S small caps.

Cautiousness on Frothy Positions

Apart from AI names, FL Putnam is also cautious on frothy positions in staples stocks. While high-quality consumer staple companies often exhibit strong financials, such as high returns on invested capital, high margins, and high free cash flow, they have become relatively expensive due to the market bidding them up. This lack of attractive options in both the AI space and the staples market has led FL Putnam to explore other areas that have been left behind, such as small caps, certain industrial sectors, and some semis names.

Trimming Staples Stocks

The trimming of staples stocks aligns with the caution surrounding frothy positions. As the market has propelled the prices of staples companies, their valuations have become less appealing. Companies like Campbell Soup, known for their strong cash flow, have seen significant price appreciation. FL Putnam believes that taking profits in this Scenario and refocusing on areas that have been left behind could be a wise strategy.

Areas of Interest: Small Caps, Industrials, and Semis

FL Putnam finds small caps particularly interesting due to their potential for growth and the valuation support they offer. Since small caps tend to perform well at the beginning of an economic cycle, they hold promise for future returns. Additionally, there are areas within industrials and semis that have seen recent pullbacks, making them potential opportunities for investors. FL Putnam is closely monitoring these sectors for potential investments.

Investing Strategies Ahead of the Fed Meeting

FL Putnam's investment strategy does not revolve around making short-term calls ahead of the upcoming Federal Reserve meeting. Instead, they focus on evaluating future earnings prospects and deploying client efforts based on that analysis. However, FL Putnam believes that the Fed will have to keep rates higher for longer than the market anticipates, leading to continued tightening of financial conditions. This expectation influences their investment decisions, but they prioritize long-term perspectives rather than short-term tactical moves.

Expectations on Profits for 2023

Earlier forecasts suggesting a 16 percent drop in profits for 2023 were deemed overly bearish by FL Putnam. While they acknowledge that earnings estimates have declined and that companies are facing challenges in pushing through inflationary costs, FL Putnam does not expect a drastic decline of that magnitude. Instead, they anticipate a more moderate decline of around 5 to 10 percent. According to FL Putnam, the top line is not expected to slow down significantly, mitigating the risk of a severe earnings growth contraction.

Highlights

  • Small caps Show potential for growth due to a six-point discount to large caps.
  • Caution is advised on AI names that have experienced significant multiple expansion.
  • Small caps perform well at the beginning of an economic cycle.
  • Trimming frothy positions is recommended, especially in consumer staples stocks.
  • Opportunities exist in small caps, certain industrial sectors, and some semis names.
  • Long-term investment strategies are favored over short-term tactical moves.
  • Profits for 2023 are not expected to decline as dramatically as some forecasts suggest.

FAQ

Q: What is FL Putnam's view on small caps? A: FL Putnam believes that small caps present an interesting investment opportunity due to their discounted valuation compared to large caps and their potential for growth during an economic cycle.

Q: Why is caution advised on AI names? A: FL Putnam expresses caution regarding AI names due to their significant multiple expansion and the potential for volatility and disappointment in stock performance.

Q: Why is it recommended to trim frothy positions in consumer staples stocks? A: The current high valuations of consumer staple companies have made them less attractive as investment options, prompting FL Putnam to advise trimming these positions and exploring other areas of the market.

Q: What areas are left behind and considered interesting by FL Putnam? A: FL Putnam is exploring small caps, certain industrial sectors, and some semis names as potential areas of investment that have not received as much attention as other segments of the market.

Q: What is FL Putnam's stance on earnings expectations for 2023? A: FL Putnam expects a more moderate decline of around 5 to 10 percent in profits for 2023, in contrast to overly bearish forecasts suggesting a 16 percent drop. They believe that the top line will not slow down significantly, mitigating the risk of a severe earnings growth contraction.

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