With markets still concerned with inflation and how the Fed might react to rate hikes, investors are gearing up for an uncertain 2022.
Francis Gannon, co-chief investment officer at Royce Investment Partners, said that small caps may be the best place to deal with these uncertainties in the new year.
I think part of the opportunity here with small caps is that they haven't done as well as some other asset classes, Gannon said on Yahoo Finance Live video above Small caps are about 8% below their most recent high and yet fundamentals for many businesses continue to improve. The industries that performed the best within the small cap space in Q 4th, 2021 were industrials, financials and information technology, according to Gannon.
He said that those areas represent a great opportunity in a world where people are concerned about inflation, wage pressure, and et cetera. These areas are good opportunities within the small cap space. He said that the small caps this year are the economy for the U.S. due to the widening participation in growth small cap companies that are demonstrating within the indices compared to their larger-cap peers.
If you looked at the equal-weighted index - so the equal-weighted Russell 2000's performance against the cap-weighted index, you would have seen that it had done much better than the overall index, he added.
In contrast, Gannon noted that the large cap space, where cap-weighted indices are underperforming their equal-weighted counterparts, is where the opposite is happening.
On top of concerns surrounding the Fed's ongoing tapering, Gannon said that the threat of higher volatility in 2022 and historical performances are the most significant risks to strong returns in the small cap space.
He said that one of the things people aren't thinking about is in the small cap space, we've had three double-digit return years in a row, something that we've only seen twice before in the history of Russell 2000. It was the last time we saw it in the mid-90s, '95 through '97. We tend not to see that fourth year of double-digit returns. Gannon believes that the market returns will be muted compared to 2021 - contrary to other experts opinion that the theme for 2022 will be a growing but slowing economy, with small caps edging out their large-cap peers due to strong, broader earnings growth.
Gannon still believes that small cap equities are undervalued because of the Omicron variant surge.
He said that there's going to be volatility around the taper because of the effects of inflation. Small caps are cheap on a relative basis, and that's the opportunity here.