Small caps had ‘worst start to a new year’ but Q3 promises growth – Jefferies

Seeking Alpha News (Wed, 02-Apr 12:26 PM)

Small caps (NYSEARCA:IWM) saw their worst start to a new year since Covid in 2020, with the Russell 2000 (NYSEARCA:IWM) down almost 9%, lagging large and mid-caps.

Small-caps (IWM) are off 17.2% since their index’s Nov. 25 peak, and are now pricing in “an ugly recession,” said Steven G. DeSanctis, U.S. small-mid cap strategist at Jefferies.

The average drop in the first half of a recession year has come in at -13.8%,

“Earnings growth has fallen, not worse than last two years, however now Street is looking for large to hold up better than small and higher volatility thanks to DC has been creating havoc,” he said. “Rough is another ‘R’ word we are using with Small's losing streak at record.”

The Russell 2000’s (IWM) P/E is at 17.x, down from 19.6x due to its underperformance, and Jefferies analysts believe it will continue to get cheaper in the third quarter, and they expect better performance.

The Russell 1000’s (IWB) P/E also fell to 20.7x vs. 21.1x last month.

“Our relative valuation model continued to tumble, and it is now in the 7th percentile vs. the 10th,” said Steven G. DeSanctis, U.S. small-mid cap strategist at Jefferies. “This is the cheapest small has been vs. large since November '23.”

The Russell 2000 Value’s (IWN) P/E now stands below 15x, compared to 20.8x for the Russell 2000 Growth (IWO).

In addition, the rolling 10-year annualized difference between small and large caps is at -6.9% annually, the widest gap since December 1935. Over this time frame, large caps (SP500) have gained 12.7% annually vs. 5.9% for small caps (IWM).

“Every additional month of underperformance by small vs. large sets a new record in terms of cycles, with this one currently at eight years and three months,” said DeSanctis.

However, fourth quarter figures turned up for the first time since 2022 for small caps, he added, with earnings beats much wider than average. First quarter estimate growth has fallen to -8.4% for small caps, compared to -2.2% at the end of last month. Growth rate for 2025 now stands at 9.8% for small caps vs. 10.2% for large caps.

“The Street now sees Q3 being the turning point for small vs. large instead of Q2, with small seeing 15.9% growth vs. 10.4% for large,” DeSanctis said.