Why do small caps often recover faster than blue chip stocks?

By Navarre Trousselot. Published at Aug 21, 2020, in Investor 101

The global pandemic has shocked the world’s economies and financial markets.

With the situation evolving daily and no-one really sure how things will look six months or a year from now, some investors are trying to envisage what the ‘recovery’ might look like.

This post isn’t about predicting how much carnage is yet to play out on the financial markets — or when the recovery might come.

Rather, we’re going to take a look at a type of stock that, historically at least, has a record of bouncing back harder and faster than others.

These stocks are small caps — stocks with relatively small market capitalisations.

In Australia, that generally means a stock with a market cap of up to $400 million (whereas Australia’s large cap stocks make up the top 50 companies trading on the ASX, generally with market caps in the billions).

Rebound rockets: why small caps have tended to pop first when markets recover from a crash

According to Institutional Investor, small companies can begin to rebound faster than larger companies in growing economies.

The reason for this is easy to understand.

Imagine two aircraft, one a huge Airbus passenger jet and the other an F-16 fighter jet.

They take off at the same time.

The Airbus needs a long runway and gathers speed gradually before lifting off.

The F-16, on the other hand, rockets into the sky at breakneck speed.

Once in the air, the Airbus can’t manoeuvre nearly as well as the F-16, which can roll and dive blindingly fast.

(But, the Airbus — large cap stocks — can of course travel much further and give its passengers a much more comfortable ride. There’s no in-flight meal on a fighter plane.)

This analogy explains why small cap stocks can be first to produce gains in a recovering stock market.

A small cap company tends to be lean, efficient and geared toward aggressively pursuing opportunities, whereas an established blue-chip company may be carrying large amounts of debt and be more dependent on the wider economy.

In the five years after the GFC, the Russell 2000 Value Index (the US benchmark index for smaller stocks) outperformed the S&P500 by about 50%.

Of course, this doesn’t guarantee small caps will repeat this feat when the markets eventually do enter their next recovery or boom.

Small caps do tend to get hit harder in a down market

Going back to our aircraft analogy, the advantages small cap companies have in recovering markets have a flipside.

Small caps — with smaller market caps and less established business operations — tend to get hit harder when markets drop.

Where the F-16 is built to fly combat missions (like a small cap company competes with other companies for success and survival in markets), it is of course the less safe and stable aircraft.

The Airbus on the other hand can fly at high altitude for a very long distance.

And if we want to bring market sentiment into this already stretched analogy, which of these planes are most people likely to choose for a trip across hostile airspace?

The Airbus every time. Bigger, safer and less likely to go down.

Navarre is the Founder of Navexa — a portfolio analytics service made for Australian investors. Navarre left a lucrative corporate developer job to combine two of his passions; investing and entrepreneurship. He created Navexa because he couldn’t find a portfolio analytics service that met his own high standards. Now, he’s focused on helping as many Australians as possible get more from their portfolios through the smart and creative use of data. Follow Navarre on Twitter and connect with him on LinkedIn.


Where to invest $1,000 right now

When the experts at Next Investors have a stock pick, it may pay to listen.

The Next Investors have been investing in ASX small cap stocks for years, with their best small cap picks yielding returns of 1,200%, 1,120%, 900% and 678%.

They have just revealed their hand-picked, FY2021 stock portfolio of high conviction long-term investments.

Click the link below to see what they are currently investing in.


SEE THE PORTFOLIO

S3 Consortium Pty Ltd (CAR No.433913) is a corporate authorised representative of LeMessurier Securities Pty Ltd (AFSL No. 296877). The information contained in this article is general information only. Any advice is general advice only. Neither your personal objectives, financial situation nor needs have been taken into consideration. Accordingly you should consider how appropriate the advice (if any) is to those objectives, financial situation and needs, before acting on the advice.

Conflict of Interest Notice

S3 Consortium Pty Ltd does and seeks to do business with companies featured in its articles. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this article. Investors should consider this article as only a single factor in making any investment decision. The publishers of this article also wish to disclose that they may hold this stock in their portfolios and that any decision to purchase this stock should be done so after the purchaser has made their own inquires as to the validity of any information in this article.

Publishers Notice

The information contained in this article is current at the finalised date. The information contained in this article is based on sources reasonably considered to be reliable by S3 Consortium Pty Ltd, and available in the public domain. No “insider information” is ever sourced, disclosed or used by S3 Consortium.

Australian ASX Small Cap stocks | Why Finfeed.com is Australia’s leading small cap publication

Founded seven years ago, Finfeed.com is Australia’s leading and longest standing website for investor and finance news, education and expert opinion.

Published by StocksDigital, Finfeed was created to report daily on the comings and goings of ASX listed stocks in the small cap market.

As the first digital publication dedicated specifically to this space, Finfeed soon became the most trusted publication in the market, quickly garnering over two million page views – a number that continues to rise.

Finfeed.com provides its readers with informative articles that tackle the latest in market moving #ASX small cap news, plus exclusive content you won’t find anywhere else. It is aimed at those with an interest in investing, market education, company performance, start-ups and much more.

Finfeed.com is the only media organisation operating under the strength of a Financial Services License and is backed by leading journalists and analysts all with brands of their own.

The website aims to inform, educate and entertain with content that drills down into the heart of financial matters.

Finfeed is a leading source of investor and market information, with everything investors need to know about how to invest written in a way that anyone can understand. 

Over the years, the website has expanded beyond exclusively reporting on small caps, to profile Australia’s leading ASX listed small, mid and large caps as well as some of the country’s most successful CEOs and business leaders to find out what makes them tick.

Every day you will find fresh content covering:

Fast Facts

Over 4,000 articles published

Over 2.3 Million Page Views and counting

Over 10,000 followers on social media

Subscriber list growing by 2% monthly

Thanks for subscribing!

X