#53 Weekly Charts — Small-Large Cap Stocks & Copper
Topics of the day:
- Small-Large Cap Stocks
- Copper Momentum
Small-Large Cap Stocks
Royce Investment Partners
THE POSITIVE MARKET AND ECONOMIC ENVIRONMENT FOR SMALL CAPS
Our view of the current state of small cap valuations is, perhaps unsurprisingly, contrarian: we see no cause for alarm. Valuations based on the equity risk premium, which incorporates current interest rates, offer a more revealing signal in our view than the more widely used P/E versus the historical range valuation metric. The current equity risk premium — the latest 12 months’ free cash flow divided by enterprise value, minus the 10-year Treasury yield — sits near the high end of the 0–1% range, which has historically preceded three-year periods with attractive results, average annualized returns in the low double digits.
Additionally, the current economic expansion seems likely to be both favorable for small caps and lead to superior results versus large caps. We turn to history for guidance. During periods of strong economic growth, small caps have enjoyed a decided performance edge over their large cap siblings. When nominal U.S. GDP growth exceeded 5% in year-over-year periods, the Russell 2000 beat the Russell 1000 65% of the time, with an average annual return of 22.1% versus 17.0%. This is especially relevant to the current environment because consensus projections call for nominal GDP growth in the 7–9% range for 2021 and 5–6% for 2022.
RELATIVE VALUATIONS FAVOR VALUE
Despite small-cap value’s recent strong performance, it remains significantly undervalued compared to small-cap growth. In fact, using our preferred valuation metric, Enterprise Value/Earnings Before Interest and Taxes (EV/EBIT), small-cap value was near its lowest relative valuation versus growth in 20 years at the end of 1Q21. We think this extreme relative valuation spread suggests that there’s more to come for small-cap value’s outperformance.
Merrill Lynch CIO
While certain risks remain, it’s our view that the economic backdrop should remain supportive for Small-caps as coronavirus concerns begin to abate, U.S. GDP growth solidly expands, and the services economy continues to recover. Steeply discounted valuations should continue to make Small-caps appear attractive, and strong forecasts for earnings growth remain as a tailwind. From a portfolio positioning perspective, investors may want to avoid riskier unprofitable companies and instead consider Small-caps that offer quality, Value and dividend-growth.
Wells Fargo Investment Institute
ECONOMY AND EXCHANGE RATES
Our view is that 2022 will be an important transition year for a global growth cycle largely shaped by the pandemic. We expect global economic growth to slow. Even with that downshift, the global economy easily should outpace the 3.3% annual average from 1980–2020.
We expect consumer-led strength in the U.S. to serve as the global growth locomotive through the first half of 2022. The U.S. growth pace should remain solid, as support to manufacturing shifts from catch-up spending to inventory restocking,
Outside the U.S., economic growth should be less synchronized with the U.S. during much of the year. Beyond potential outbreaks of the coronavirus is the uneven impact of higher fuel costs that hit hardest at Europe and Asia. Broadening vaccination coverage should help the international economies in the second half of the year.
A shortage economy will likely keep inflation elevated before supply chain pressures ease and allow inflation to subside during the year’s second half. The upside risk is that rent and wage increases become self-sustaining, but our conviction is inflation should ease.
Before the COVID-19 pandemic shook up the automotive industry — along with every other industry — electric vehicles were moving steadily into the spotlight. The combined annual sales of battery electric vehicles and plug-in hybrid electric vehicles tipped over the two-million-vehicle mark for the first time in 2019. This much-anticipated milestone may have become overshadowed by economic uncertainty and changed consumer priorities, but there is value in taking stock of the electric vehicle market even now.
Since the last time Deloitte reported on EV sales, significant regional disparities in growth have surfaced. For example, sales of EVs grew by 15 per cent in 2019 compared to 2018, driven by the growth of BEVs in Europe (+93 per cent), China (+17 per cent) and ‘other’ regions (+22 per cent). In contrast, the United States market for BEVs fell 2 per cent (see figure 1). Then, in the first half of 2020, COVID-19 slowed down the growth rate of EV sales, or sent it into decline, across various regions. The speed of recovery is expected to vary by region.
Our global EV forecast is for a compound annual growth rate of 29 per cent achieved over the next ten years: Total EV sales growing from 2.5 million in 2020 to 11.2 million in 2025, then reaching 31.1 million by 2030. EVs would secure approximately 32 per cent of the total market share for new car sales (see figure 2).
Annual car sales are unlikely to reach pre-COVID-19 levels until 2024. However, the pace of recovery is forecasted to be a result of a slowdown in ICE sales; EVs will continue to have a positive trajectory during the COVID-19 recovery period and may well end up capturing a disproportionate share of the market in the short term.
THE OUTLOOK FOR ZERO-EMISSION VEHICLES HAS IMPROVED MARKEDLY
Long-term outlooks for battery electric and fuel cell vehicle adoption have become more bullish in the last two years. Companies forecasting ZEV adoption now see tens of millions more battery electric vehicles (BEVs) and fuel cell vehicles (FCVs) on the road in the future than they expected in 2019.
In its 2021 Long-Term Electric Vehicle Outlook, BNEF projects the global passenger and commercial ZEV fleet to hit 677 million vehicles by 2040. In 2019, this forecast called for just 495 million ZEVs on the road in 2040. The latest outlook sees passenger ZEVs making up 39% of the 2040 passenger vehicle fleet, up from 26% in the 2019 report. Commercial ZEVs hit 24% of the 2040 commercial fleet in EVO 2021, up from 19% in 2019. In total, across passenger and commercial vehicles, the 2040 ZEV fleet share went from 25% in 2019 to 36% in the 2021 report.
Other firms have also become more bullish in their most recent publications, increasing their ZEV adoption outlooks. The IEA’s latest Global EV Outlook* increases its BEV fleet by 7%, to 91 million in the 2021 report, from 86 million in 2019. OPEC has revised its projected 2040 EV and FCV fleet up by 11% in its most recent World of Oil publication, to 369 million EVs and FCVs on the road.
My conclusions and considerations
- As we have seen, small caps better reflect what a country’s economy is, and if the economy is doing pretty well, they tend to outperform generally large cap.
- The value sector of small caps seems more discounted than the growth sector, despite the appreciation it has had in recent periods.
- I have already written about copper here if you want to look at it, but the trend seems marked, even if from my point of view making forecasts over a period of more than 5 years could be misleading.
- The demand for copper is estimated to grow for the next 20 years, and surely is a trend that has certainly be monitored, as this trend include increased consumption of electronics, the proliferation of electric vehicles, the increased use of renewable energy sources and energy efficiency — all of which require significant amounts of copper to function.
Join the conversation with your own take on these topics in the comments below.
About the Author
Alessandro is a Financial Markets enthusiastic and he loves learning from articles/papers on many financial topics and in doing so he shares with you the most interesting charts and comments.
This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. This material has been prepared for informational purposes only. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.