A Credit Suisse Group AG logo sits above a building in Bern, Switzerland, on May 20, 2014.Philipp Schmidli/Bloomberg
Among U.S. equities, the tide is turning in favour of small-caps, says Credit Suisse.
In a recent report, chief U.S. equity strategist Lori Calvasina and strategist Sara Mahaffy noted that small-cap stocks are less expensive than their larger peers. Credit Suisse's valuation model shows large cap valuations are currently at a level that has typically been followed by a 6-per-cent retreat in the S&P 500 over the next twelve months, and mid-caps look even more stretched. Small caps are not inexpensive but valuations in the space are more attractive, at levels that herald an average 2-per-cent return over the next year.
"The case for large cap continues to deteriorate, while the case for small cap continues to strengthen," they write. "Small caps are currently the cheapest they've been relative to large caps since the end of the Tech bubble."
U.S. large caps are falling out of favour, with investors selling those exchange-traded funds and rotating into their European counterparts. In a separate note, Bank of America highlighted "euphoric" inflows of $31-billion into European equity funds over the past eight weeks, the largest since the end of 2008, in anticipation of the full-scale quantitative easing program launched by the European Central Bank. However, since the start of the year, U.S. small and mid-cap ETFs have been supported by modest inflows.
Further, the effect of the stronger U.S. dollar has dampened large and mid-cap companies' fourth-quarter results, as bigger firms generally have more exposure abroad than smaller one, and dampened the forward outlook. Using the Russell 2000, a proxy for U.S. small-cap stocks, the percentage of companies that beat on earnings and revenues rose, but the share of large-cap companies that exceeded analysts' expectations on these metrics declined.
The U.S. dollar index is sitting near an eleven-year high, and was a huge theme in fourth-quarter earnings reports and conference calls. Accordingly, earnings per share estimates for mid- and large caps have been revised to the downside more than for small caps.
However, Credit Suisse isn't yet willing to recommend that investors overweight small caps over large caps, holding a neutral stance compared to its underweight small caps call for 2014.
The analysts say that the first rate hike from the Federal Reserve, which they foresee occurring in June, could be "a likely stumbling block for the small cap trade." The Russell 2000, Ms. Calvasina and Ms. Mahaffy write, usually experiences larger declines than the S&P 500 around the commencement of a tightening phase.