Small-cap stocks started the year with strength but began to diverge from large-cap stocks in early March. Despite a mid-April rally and another in May-June, small-cap stocks haven’t yet caught up with their larger compatriots in the equities markets.
This isn’t the whole story, however. The Russell 2000 hit an all-time high on July 25th, while the S&P 500 hits its peak the next day, July 26th. Driven by positive earnings reports and positive economic data, the markets ignored a tightening monetary policy and diminishing chances for fiscal stimulus coming out of the nation’s capital any time soon and stocks bounded upwards.
The bull case for domestic small-cap outperformance in the second half of the year looks to several factors.
First, corporate earnings across the board, for both small and large companies, continue to show strength.
Second, economic indicators are pointing to accelerating growth in the second half of the year, including the following:
Housing starts have been positive, confounding non-data driven pessimism about the homebuilding industry. This bodes well for continued outperformance for companies like LGI Homes (LGIH, up 40% since December 1, 2016), Century Communities (CCS, up 44% since August 1, 2016), and Essent Financial (ESNT, up 4% since April 3, 2017).
Interest rates are likely to climb higher fast enough or to heights that would greatly impede corporate capital needs. However, rising rates will continue to improve the lot of bank stocks. First Foundation (FFWM, up 13.5% since March 31 2017), Investors Bancorp (ISBC, up 11.5% since August 31, 2016), and South State (SSB, up 7.6% since July 31, 2015). We’re also looking for continued strength from Columbia Banking (COLB, up 46% with dividends since February 28, 2015), though the company is coping with the unexpected death of its long-time CEO.
In general, consumer spending appears to still be strong, fueled by low interest rates which have contributed to rising credit card debt and an improving labor market. Specialty retail stocks should fare well in the face of threats from Amazon, dealing as they do with lower-cost or unique goods not handled particularly well by the Internet retailing giant. Five Below (FIVE, up 18.2% from December 31, 2016), Duluth Holdings (DLTH, down 18.2% from April 29, 2016), and Winmark (WINA, up 32.9% from July 29, 2016) are poised to benefit from continued consumer optimism.
Finally, semiconductor stocks continue to look positive for the second half of 2017. Gartner released an industry outlook in April that projected overall growth of 12% for the industry, up from their earlier 7.2% growth expectation. Second quarter growth appears to support this revised vantage point, and companies like Skyworks Solutions (SWKS, up 35.9% since October 31, 215), Silicon Motion Technology (SIMO, down 16.8% since May 20, 2017), Cirrus Logic (CRUS, up 176% since May 5, 2013), Ambarella (AMBA, down 8.5% since December 31, 2015), and Applied Optoelectronics (AAOI, up 550% since March 31, 2016) could be rewarded by the uptick in demand.
As always, prudent stock selection driven by a focus on fundamental growth and quality, paired with a determination of fair value, is the key to long-term investing success.
Reprinted from the July 2017 issue of the SmallCap Informer stock newsletter.