The stock market has been on a rollercoaster ride in recent years, with big tech stocks leading the charge. However, a new trend may be on the horizon as historical outperformers are poised to take the spotlight.
One key indicator that investors should pay attention to is the gap in the forward price-to-earning (P/E) ratios of the S&P 500 index and the S&P 600 index. As of June, the gap between the two indexes was at its widest since 2001, with small-cap stocks historically outperforming large-cap stocks during similar periods.
The current market situation is characterized by a heavy weighting of a few big tech stocks in the S&P 500, leading to higher-than-average valuations. This concentration of stocks is reminiscent of the dot-com bubble in 2000, suggesting that a shift towards small-cap stocks may be on the horizon.
Despite recent challenges faced by small-cap stocks, such as rising interest rates and increased risk premiums, the tide appears to be turning in their favor. With expectations of the Fed lowering interest rates and the AI-fueled growth of big tech companies slowing down, small caps are poised to outperform large caps in the coming years.
Investors looking to capitalize on this potential shift can consider adding small-cap stocks to their portfolio through index funds like the SPDR S&P 600 Small Cap ETF or the Vanguard Russell 2000 ETF. Additionally, focusing on small-cap value stocks, such as those included in the Avantis U.S. Small Cap Value ETF, could provide concentrated exposure to outperforming assets.
While it may take time for the market dynamics to fully shift, all signs point to small-cap stocks as the next driving force in the market. As investors brace for potential changes in the market, staying informed and diversifying their portfolios with small-cap stocks could be a strategic move for long-term wealth creation.
