Investors should look past short-term volatility and focus less on which style to overweight and more on prudent company selection as valuation gaps have narrowed significantly in the past year.
Last week was a volatile ride, as markets digested news of Silicon Valley Bank’s failure, the government’s response and concerns regarding several other banks. Investors are now questioning what this means for their equity portfolios. Last week, the focus shifted toward quality and safety, leading large cap stocks to outperform small cap, with the S&P 500 and Russell 2000 indexes finishing 1.5% higher and 2.6% lower, respectively. This can be explained by small cap’s larger exposure to financials at 18.5%, compared to large cap at 10.5%. Moreover, within financials, banks account for the majority of small cap’s weighting compared to just 31% of large cap’s weighting. While small cap underperformed large cap by 86% over the past 15 years, leaving valuations at very discounted levels, large cap continues to look favorable in the current environment given its greater exposure to defensive sectors. Additionally, the current net profit margin for the Russell 2000 is 4.6%, starkly lower than the S&P 500’s 12.3%, reflecting small cap’s increased vulnerability to elevated costs.
When it comes to style, growth outperformed value last week by 5.8% due to its lower weighting to financials and a pivot back to tech as Fed tightening expectations softened. Value will most likely face further headwinds in the near term due to its exposure to bank stocks. However, investors should look past short-term volatility and focus less on which style to overweight and more on prudent company selection as valuation gaps have narrowed significantly in the past year. While macroeconomic uncertainty and higher interest rates pose challenges for all companies, investors can best weather the storm by emphasizing quality within different market caps and styles.
Source: FactSet, J.P. Morgan Asset Management