Financial Industry Insights from Advisors Asset Management


AAM Viewpoints – Mind the Caps….

U.S. equities, as measured by the S&P 500 Index, are hovering near all-time highs after capping off a very strong first half of 2019. The gains look impressive and one of the more bullish indicators for the market going forward has been the broad participation or breadth of the rebound following a volatile end to 2018. Every asset class benchmark we track is positive year-to-date, and all but two are positive year-over-year (as of 7/10/2019).

One of the groups that remains in negative territory over the last 12 months that is getting some attention is Small-cap equities. The S&P Small-cap 600 Index has a total return of -8.93% from 7/9/2018-7/10/2019 (the other benchmark we track that is negative is the S&P 500 Energy Sector Index at -13.68%). Meanwhile the Large-cap S&P 500 Index has gained 9.69% over the same period, outperforming Small-caps by a whopping 18.62%. And while Large-caps are hitting fresh all-time highs, Small-caps remain 13.62% off their peak set back in August (price basis, 8/31/2018-7/10/2019).

Table 1: Total Returns


Source: AAM, Bloomberg Data as of 7/10/2019 | Past performance is not indicative of future results.

It’s not all bad. Small-caps have gained 13% year-to-date, but the group seems to have leveled off since February while their Large- and Mid-cap counterparts have continued to march higher. The irony is the underperformance comes in an environment that could be advantageous to the Small-cap space. The theory is Small-caps generate a larger portion of their revenue domestically (approximately 78%) and could see a greater benefit from the relatively stable U.S. economy and be insulated from trade disputes, tariffs, etc. The last 12 months have put that theory to the test as we have experienced “peak trade war” and yet the Large-cap bias in the market remains. In fact, the Large-cap S&P 500 has outperformed the S&P Small-cap 600 four out of the last five years.

This is having an interesting effect on valuations. About 35% of the Small-cap universe is not profitable and does not have measurable earnings therefore our preferred measure is price to sales ratio. As you can see in the table below the S&P Small-cap 600 Index is trading right at long-term averages (table 2). However, the recent divergence in returns has pushed relative valuations compared to the S&P 500 Index well below long-term averages and to levels not seen since 2001 (chart 1).

Table 2: Historical Valuations


Source: AAM, FactSet Data | Past performance is not indicative of future results.

Chart 1: S&P Small Cap 600 Price-to-Sales Ratio - Relative to S&P 500

S&P Small Cap 600 Price to Sales Ratio – Relative to S&P 500

Source: FactSet | Past performance is not indicative of future results.

Another way of looking at it is the spread between the price to sales ratio of the two groups. Similar to the data above, the spread has widened to levels not seen in about 20 years (chart 2).

Chart 2: Price-to-Sales Ratio - Spread AnalysisPrice to Sales Ratio – Spread AnalysisSource: FactSet | Past performance is not indicative of future results.

Earnings for the S&P Small Cap 600 Index are expected to grow 28% over the next 12 months; about double the S&P 500 which is expected to grow earnings per share by 14%, according to analyst consensus compiled by Bloomberg. This should be supportive of equity prices in general and could be a catalyst for Small-caps to close the gap. We could argue if the current discount is appropriate but at this juncture we simply recommend taking a look market-cap exposure to see if Large/Small-cap allocations remain in-line with target corridors. Not necessarily tomorrow, but at some point, we would expect Small-caps to revert to an average valuation compared to the broad market which could pay off nicely for disciplined investors who maintain exposure during this period of underperformance.


CRN: 2019-0715-7552R  

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit



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