How should investors position themselves to benefit from a possible stock market recovery? According to experts at US fund manager Alger Management, small caps outperform their larger counterparts during the upswing. If we look at the average performance one year after the bottom of the last three recession lows, i.e. twelve months after October 31st, 1990, September 30th, 2001 and February 28th, 2009, we can see that mainly stocks in the Russell 2000 Index, which comprises small and medium-sized companies and microfirms, rose by around 38 percent in the following twelve months. The S&P 500 Index rose by only 22 percent by comparison. Investors tend to prefer larger stocks due to their relative safety and liquidity, which has meant that small caps have performed well below average in 2020 so far. The result has been a decline in their valuations and thus a potential increase in attractiveness.
Although small caps are generally traded at a higher price than large caps, small caps have clearly fallen short of expectations. High valuation discounts were the result. Looking at the price-earnings ratio, this discount is the most drastic in two decades. If investors take the advice of Alger Management, they should go on the offensive and consider high-quality small caps.
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