Our Top Market Takeaways for March 3, 2023

Market update: It’s getting warmer

…and the slew of strong data of late (from manufacturing, to inflation, consumption and jobs) has been too hot for markets to handle.

Bond yields have gone on another tear higher—2-year Treasury yields breached 4.9% for the first time since 2007, and the 10-year is back above 4% for the first time in four months. February’s surge was the largest monthly jump since September. Bonds are back on the menu, and the latest moves give investors another chance to bite.

And while higher rates have led to some weakening in stocks over the last three weeks, the S&P 500 is sitting at the same level (3,970) it was in May 2022, when the Fed was expected to only hike interest rates to 3%. Stocks are holding up pretty well considering 10-year yields have jolted over 100 basis points since then and markets are now pricing Fed policy rates to get to 5.5%.

Stocks outside the U.S. are holding up even better. Core Eurozone inflation hit another record yesterday, and the Stoxx Europe 600, which includes companies listed across the region, still managed to finish the day in the green and is sitting at levels prior to Russia’s invasion of Ukraine.

Chinese stocks are also catching another bid as reopening is boosting growth in a big way. February’s Purchasing Managers’ Index (PMI) (one of our favorite leading growth indicators) smashed expectations across the board, with manufacturing activity expanding at its fastest pace in over a decade.

All that’s to say, U.S. large-cap stocks are holding up, but they may not be the only game in town. We continue to scour the market for pockets that offer compelling valuations and growth. U.S. small- and mid-cap stocks might be a hidden gem, and today we share why we think investors should consider building exposure.

Spotlight: Broadening horizons: Looking to small and mid-cap stocks

You would never shop in only one aisle of the supermarket, would you? Unfortunately, many investors do just that when it comes to their portfolios—by, for example, sticking to their home country market or to larger companies. Failing to broaden horizons or adapt to the changing tide could leave future returns on the table, especially in a shifting economic environment like this one.

We believe that the opportunity is ripe today for smaller and medium-sized companies for three big reasons:

1. Believe it or not, small- and mid-cap stocks have outperformed large-cap companies over the last 25 years.

We all tend to suffer from a bit of recency bias—we expect what happened in the past to repeat. Big tech galvanized large cap stock returns over the last decade, earning a whopping ~160% price return since then. Yet, a look at returns over the last 25 years shows us that smaller companies have actually outgrown and outperformed larger firms.

All that’s to say, the large-cap outperformance over the last few years may be the exception, not the rule.

Large cap outperformance: The exception or the rule?

2. It’s so bad, it’s good. We think valuations and earnings estimates have bottomed—cue entry point.

Over the last year, across all market capitalization ranges, estimates for corporate profits have plunged over 10%—but the largest declines have been in small-cap equities, and the pain has been so acute, we’re starting to see a bounce higher. What’s more, valuations for both small- and mid-cap companies have corrected to levels we usually see during recessions (while large-cap valuations are still in line with their long-term averages).

SMID cap valuations look attractive

3. The leaders of the next cycle likely won’t be the same as the last—and SMID cap companies could take the baton.

In the past cycle, growth was synonymous with tech, buoyed by ultra-low interest rates. Looking forward, it’s hard to see mega-cap tech companies maintaining their pace of growth, especially as key markets become more fully penetrated and valuations still look pretty stretched. On the other hand, SMID cap companies look poised to benefit from increased capital markets activity, a new era of capital expenditure (capex) spending focused on the real economy (thanks to a greater weighting toward sectors like industrials, materials and real estate), and the ongoing push to bolster supply chains amid geopolitical tensions (as companies seek to onshore their production).

Investment considerations: Get active

While we believe that large-cap stocks are generally the most important driver of capital appreciation for investors over the long term but, given the current state of the economy, there is more to the market than just the biggest companies. As cycles turn, small- and mid-cap companies tend to outperform as growth reaccelerates, and we think now is the time to consider getting exposure.

Small cap stocks tend to outperform just following recession.

But this part of the market is not without its risks—SMID cap stocks tend to be more volatile and hold more debt. In this space, it’s prudent to engage with active managers with the experience of selecting quality businesses with flush balance sheets and that are best suited to the trends of tomorrow.

Your J.P. Morgan team is here to help you discuss this potential opportunity in the context of your goals. 

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All market and economic data as of March 3, 2023 and sourced from Bloomberg and FactSet unless otherwise stated.

The Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Bloomberg Eco Surprise Index shows the degree to which economic analysts under- or over-estimate the trends in the business cycle. The surprise element is defined as the percentage difference between analyst forecasts and the published value of economic data releases.

The NASDAQ 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the NASDAQ stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.

Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk.  Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss.

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Bonds are subject to interest rate risk, credit and default risk of the issuer. Bond prices generally fall when interest rates rise.​ Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss. ​

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