Small-cap stocks (^RUT) are still trailing the S&P 500 (^GSPC) year to date, but some on Wall Street see potential for a rebound. Villere & Co Partner and Portfolio Manager Sandy Villere joins the Morning Brief to share small-cap names to watch.

Villere highlights that small-caps are under-owned, at only 4% of the broader market. While the S&P 500 is trading at a 20% percent premium, Villere says small-caps are at a 20% discount. These factors, combined with rate cut hopes, are catalysts for the small-cap sector.

Trading is crowded in names like Microsoft (MSFT), Apple (AAPL), and Nvidia (NVDA), the strategist says. It's why he gravitates toward the "empty rooms." He notes that Ligand Pharmaceuticals (LGND) has plenty of growth opportunities within small-caps, as do smaller names with a little bit of leverage, such as Caesars (CZR). He also emphasizes that regional banks are small-caps worth watching.

For more expert insight and the latest market action, click here to watch this full episode of Morning Brief.

This article was written by Gabriel Roy

Video Transcript

Small caps are trailing behind the S and P 500 so far in 2024 but a rebound could be coming at least according to our next guest and there's a few names investors should be watching for more.

We've got Sandy Valer who is the Valerian co partner and portfolio manager joining us now.

San, great to see you.

All right.

So this is the rally that it feels like we've been talking about since the end of 2023.

That could be coming for small caps, but we've seen them being outpaced.

Why is that?

And what could be the driver for when that rally does take place?

Yeah, I mean, you, you look at why small caps have underperformed.

It's amazing.

I mean, they're, they're only 4% owned in the broader market and typically that's more like 8%.

So I think they're under owned here.

And then you look at valuation, I mean, the S and P 500 is trading at a 20% premium to that 20 year price earnings multiple, whereas the small caps are trading at a 20% discount.

So I think, you know, with the cracks and some employment numbers and we'll see what we get tomorrow with payrolls.

But I think that, you know, a, a rate cut could be more probable than not, you know, as you look forward to September, maybe a 67% chance, something like that.

And I believe that, um, if rates go down small caps could really rally.

So, um, we want to be prepared for that.

Yeah, Cindy.

Is that going to be the catalyst?

Is that ultimately what we need to see a rate cut in order to see gains in these smaller cap names?

Yeah, and, and, and to my prior point, it's just they're under owned, they're cheap, you know, you look at the three year performance, the S and P is up 9.6% annualized ending May 31st and the, the Russell two thousands down 1.6%.

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I mean, that's a 10% you know, lag annualized over three years and, and they've underperformed by 5% annualized over a decade.

And if you go back, historically, more risk should equal more return if you go back to 19 th 19 thirties or something like that.

So, uh we think small cap sets up well as something that's very under owned, uh as you go into what could be, you know, rates moving lower and the bond market is smart in the stock market and the bond market has been moving down from a, you know, 460 to a 4430 on the 10 year.

So I think it's telling you that right cuts could be coming, you know, maybe the end of this year, you know, when we think back to some of the most overcrowded trades right now, II I mean, how do small caps eventually kind of benefit if we do continue to see crowding into some of the most popular and, and namely into themes like generative A I and really the mag seven here.

Yeah, I mean, you look at uh look at Microsoft Apple and video that's 20% of the S and P 500.

All those that are indexing into the spy are putting, you know, 20 cents of every dollar into those three stocks.

So it tends to be a self fulfilling prophecy, but I'm just coming back from the, the steeple Nicholas Investment Conference in Boston.

And it's funny when I'm, I'm looking at the crowded trade, I tend to go into the rooms that are empty rather than the ones that are full.

Um I want to find those, those names that are, that are under owned, you know, maybe misrepresented from a valuation standpoint and that tends to, to, to rue the day.

Um you know, at, at, you know, at the end of the day.

So Sandy, talk to me about where specifically you're seeing that opportunity within small cops because it's a pretty broad uh grouping.

So, I mean, when people, when investors out there are trying to identify where exactly they should be placing their money.

What can you tell us just about some of the characteristics that you're looking for or where more specifically you're seeing that investment opportunity?

Yeah.

II, I like a handful of small names right now.

I like a, a name li and pharmaceuticals.

Um, uh, you know, it's kind of a chicken way to play the biotech industry but it's got, you know, plenty of growth to it and, and I think it's, it's, it's underperformed and I think it's got a good opportunity to uh to outperform.

Um, I also like some of the smaller names that have a little bit of leverage.

So think of, uh Caesars, for example, it's, um, it's, it's underperformed for sure.

Um, and you just got Carl Icahn that, that bought a nice stake in the company.

It's, uh, it, it looks to me like it's got a great chance of, of outperforming.

Um, again, if you get rate cuts a little bit of leverage, um, that could be like gasoline on, on the stock, on the, on the upside.

So, yeah, I look forward to, you know, seeing how that can, how that can play out.

What about in utilities?

Are there small cap utility plays right now?

I mean, that, that's the thing that we hear about next with regard to kind of the energy that's going to need to be required to power a lot of these data centers given the demand that's ballooned for generative A I, yeah, that, that's definitely a way to play it.

I mean, something like an Exelon or something like that.

Larger cap.

But um I think the data warehouses are definitely going to build out.

Um I own some Freeport mcmorran, FCX.

That's, that's putting all the electrification into not only the data center warehouses but also electric vehicles and, and, and just infrastructure build.

So, um I actually like, I like the way that uh Freeport is setting up is a little bit of a larger cap, but one that I think works well and, and kind of back to the prior question about, you know, where I'm looking in, in small cap lands.

I mean, regional banks have been a, um, you know, almost a four letter word.

Uh And I think there's plenty of opportunity there.

Um And in fact, the last thing that I added to the portfolio was a small regional and, and um in, in, in Montana, uh FIBK first Interstate Bank, so a nice seven and a quarter percent dividend yield.

And I think you just need to, you know, the stock just needs to go from 26 to 28 and you get a nice return looking out, you know, 12 months and I think the risk is much lower than what you'd see in, you know, certainly an overpriced tech stock.

All right, Sandy Valer Valeron Co A partner and portfolio manager.

Thanks so much for joining us here this morning.

Thanks Shawna.

Thanks Brad.