Milan Cacic
July 19, 2024
Money Financial literacy Economy Commentary Trending Weekly update Weekly commentaryLESS IS MORE!
This past week on the market was pretty extraordinary with regard to the rotation out of technology stocks. At one point during the week, the NASDAQ 100 (large-cap tech) was down 3% while the Russell 2000 (small-cap equities) was up 1%.
Now let's be clear – these large-cap tech stocks, which have driven the market for the past year, have mostly justified their increase in stock prices because of their earnings growth. However, while all the investable money poured into six or seven large-cap names, the small-cap market was left to wither on the vine. As a consequence, the price-to-earnings multiples of these large-cap companies are trading at significant premiums relative to the small-caps.
If you're wondering why money is now starting to rotate from large-cap equities into small-cap equities, just take a look the chart below. The chart below is broken into 20% quintiles based on the market capitalization of companies in the S&P 500. As you can see, the largest 20% of companies in the S&P 500 were trading at 21.8 times their forward earnings, while the smallest 20% of companies were trading at only 15.1 times their forward earnings. There is no doubt that larger companies deserve to trade at a higher multiple because of size and in dominance in respective sectors, however a 44% premium seems too high.
If we take a look at price-to-sales, the relative premium is even greater:
Anyway you look at it, small-cap stocks are considerably cheaper than large-cap stocks. As we've said in previous notes, in order to close this gap, either large caps have to come down, or small caps have to go up. It will most likely be a combination of both.
I have also included a piece from our CIBC economics team entitled “The unredacted Bank of Canada”.
As always, if you have any questions, please feel free to give us a call at any time.
Have a great weekend.
Milan