(Bloomberg) — Smaller US companies are enjoying a robust earnings season amid resilient economic growth, suggesting a recent market rotation away from technology heavyweights has further to run.
About 65% of Russell 2000 constituents have exceeded fourth-quarter profit expectations so far, the largest proportion since mid-2021, according to data compiled by Bloomberg Intelligence. By contrast, the beat rate for S&P 500 firms is the lowest in three quarters.
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Morgan Stanley strategist Michael Wilson said small caps are also seeing their best revisions breadth — the number of analysts raising estimates against those cutting them — since August.
“These developments are supportive of our small cap relative preference amid a return of positive operating leverage,” Wilson wrote in a note.
The trend marks a turnaround for small-cap stocks, which had been hamstrung by higher interest rates and sluggish economic growth because of their thinner margins and relatively high debt loads. However, their shares have finally begun to outperform as the Federal Reserve cuts rates and the US avoids a recession.
At the same time, investors are growing more nervous about hefty investments into artificial intelligence. The tech-heavy Nasdaq 100 sank as much as 4.3% last week before rebounding slightly. Sectors that are deemed to be at risk from AI have also been roiled.
The Russell 2000 index is beating the S&P 500 by more than 6 percentage points this year and is on track for its strongest outperformance in a decade.
“The market isn’t just going to be reliant on a small group of large tech companies and can broaden to other stocks in other sectors which are driven by the economy,” said Gary Paulin, chief investment strategist at Northern Trust Asset Management.
Solid results from the cohort this season have been rewarded. Communications equipment maker Viavi Solutions Inc. surged 18% after posting better-than-expected earnings. Synaptics Inc. also advanced as it issued an encouraging outlook. On the other hand, the bar has been much higher for S&P 500 earnings to impress.
At RBC Capital Markets, strategist Lori Calvasina said Russell 2000 companies are enjoying a higher rate of earnings revisions relative to the large-cap index, “indicating that the S&P 500 has lost dominance from this perspective.”
