Equities in Focus

Strong Returns and Earnings Range
 

Small-cap equities have continued to strongly outpace many popular market benchmarks year-to-date (Display 1). These strong returns have been supported by an earnings recovery, along with a sector profile that transcends AI themes.
 

After lagging S&P 500 earnings growth and especially those of the Magnificent Seven stocks, consensus estimates have small-caps leading the pack (Display 2). And their sector exposures may also help investors diversify the source of those earnings. Display 3 shows that AI build-out sectors represent about 17% of the Russell 2000 versus nearly half of the S&P 500. Conversely, sectors more closely connected to the broader US economy represent a larger portion of the Russell 2000 compared to the S&P 500. Small-caps are not an anti-AI allocation but may offer a viable source of diversification from the many battleground issues developing around the AI trade.
 

Economic and Headroom Expansion
 

Indeed, small-caps offer a way to participate in more of the economy, and the economy is doing fine. Plus, their forward P/E ratios have been meaningfully correlated to manufacturing activity (Display 4). The ISM Manufacturing Purchasing Managers’ Index reached 53.3 in June, its sixth consecutive month above 50 and a level associated with expansion. Meanwhile, the Russell 2000 represents only about 5.5% of the S&P 500’s market value (Display 5), still well below its longer-term footprint, which argues for measurable rerating potential.
 

Our View
 

Small-caps remain cyclical, rate-sensitive and highly dependent on company selection. But after years of being overlooked, the case is no longer simply “they are cheap.” Earnings are improving, leadership is broadening, and economic support remains, which provides a sound glide path to allocate with intent in this asset class.
 

To learn more about AB’s equity investment solutions and to access other market insights, visit Equity Investments | AB.