Small Cap Stocks At Lowest Valuation In Decades, But Analyst Holds Off Buying, Citing $600B Debt Concerns

With the S&P 500 index hitting new highs 22 times in just 2024 alone, casual investors can be excused for thinking the stock market is booming.

However, given that the S&P 500 is a market-weighted index of some of the largest companies in the U.S., it certainly doesn't tell the whole story of how the economy is doing.

The Russell 2000, the commonly used index to track small-cap stocks, has been up only 2.3% so far this year, continuing a trend of underperformance compared to its larger peers.

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That underperformance does have a silver lining for investors, though, as U.S. small-cap stocks are as cheap as they've been in decades.

Whether that makes them a good investment or not is up for debate on Wall Street. The chief Market Strategist at Zurich Insurance Co. says, "The bigger, quality names are more expensive for a reason."

BlackRock's BLK Head of iShares Investment Strategy, Kristy Akullian, cites the Fed's "higher for longer" rate outlook as disproportionately hurting smaller companies and being more tied to the current U.S. economy.

Ms. Akullian further explains, "Large-cap growth stocks soared on enthusiasm for artificial intelligence, defying concerns about high rates and frothy valuations, with small caps [reacting] in a much more historically rational way to what was happening in the broader economy."

A major source of concern among investors interested in adding more small-cap names to their portfolios is the asset class’s relatively high debts and when those debts are due.

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Firms in the Russell 2000 index have a whopping $832 billion in debt, with 75% of it needing to be refinanced by 2029. 

With interest rates as high as they are, and with the Fed's policy maintaining them higher for longer than what was expected to start the year, it's easy for investors to be nervous.

The issue has led those such as State Street's STT senior multi-asset strategist, Marija Veitmane, to hold off on buying for now, saying, "despite attractive valuations, we won't be buying yet."

However, retail investors could benefit from fear on Wall Street, borrowing from an old Warren Buffett adage to "be fearful when others are greedy and to be greedy only when others are fearful."

For those willing to invest in the underperforming asset class and hope for a turnaround, the iShares Russell 2000 ETF IWM from BlackRock seems like a viable option for buying small-cap stocks without worrying about individual stock picking.

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