January 6, 2025

QuickTakes

Will SMidCaps Continue

To Underperform?

Today was another good day for technology stocks, semiconductor stocks, and the Magnificent-7. In the S&P 500, they were up 1.44%, 3.28%, and 2.01%. We continue to recommend overweighting the LargeCap S&P 500 Information Technology and Communication Services sectors. We aren't as keen on the MidCap S&P 400 or the SmallCap S&P 600 (collectively the “SMidCaps”), or especially the SmallCap Russell 2000, all of which continue to underperform the S&P 500 (chart). The latter was down slightly today.

Boosting semiconductor stock prices today was news that Foxconn's revenues rose 15% y/y. That gave Nvidia a 3.4% boost. Jensen Huang, Nvidia's CEO, is delivering a keynote address at the 2025 Consumer Electronics Show this evening.

The relative underperformance of the SMidCaps since mid-2022 is attributable to the relatively flat trends in their forward earnings over the same period, while the forward earnings of the S&P 500 has been rising to new record highs since mid-2023 (chart). This divergence is unusual. Our theory is that the profitable SMidCap companies with the most potential to become LargeCaps are getting acquired by LargeCap companies before they can do so.

The S&P 500’s and S&P 400’s forward revenues have been rising in record-high territory since mid-2022, while the forward earnings of the S&P 600 has been flat-lining over this same period (chart).

While the forward profit margin of the S&P 500 has been rising to record highs recently, the forward profit margins of the S&P 400 and S&P 600 remain below their early 2022 peaks and well below that of the S&P 500 (chart).

The forward P/Es of the S&P 400 and S&P 600 rose from about 14.0 to 16.0 last year. That multiple expansion accounted for most of last year's rally in both price indexes, as their earnings were disappointing (chart).

We're not sure why the Russell 2000 is widely used as a benchmark index for SmallCaps. Over 30% of the companies in the index are losing money. That explains why the forward P/E of the Russell 2000 is much higher than that of the S&P 600, which is our preferred benchmark for SmallCaps (chart).

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