Investors Could Find Opportunity in Undervalued Segment of Stock Market

Investors might be undervaluing an entire segment of the stock market, and it could lead to a decade of outperformance. The S&P 500 has been hitting new all-time highs in 2024, driven by big tech stocks and their innovations in artificial intelligence. However, a significant valuation gap between large-cap and small-cap stocks suggests that smaller companies could be the next big opportunity for investors.

The forward price-to-earnings (P/E) ratio of the S&P 600 small-cap index is currently much lower than that of the S&P 500 large-cap index. Historically, when this gap has been wide, small-cap stocks have outperformed their larger counterparts. For example, from 2001 to 2005, the S&P 600 generated a total return of 66.7%, compared to just 2.8% for the S&P 500.

Factors such as high interest rates and recession fears have held back small-cap stocks in recent years. However, with the Federal Reserve expected to cut interest rates and easing recession concerns, now could be a great time to invest in small caps. Investors can research individual companies or use index funds like the SPDR Portfolio S&P 600 Small Cap ETF or the iShares Russell 2000 ETF to gain exposure to this potentially lucrative segment of the market.

While large-cap stocks still have their place in portfolios, considering a tilt towards small caps could be a smart move in today’s market. With the potential for significant outperformance, investors may want to explore the opportunities presented by undervalued small-cap stocks.