米国株見通し：小型株の魅力について

This is an audio transcript of the Talking Heads podcast episode: US stocks: small is also beautiful

Andrew Craig: Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we’ll be discussing US small-cap stocks and recent developments in the sector. I’m Andrew Craig, Co-head of the Investment Insight Centre, and I’m joined by Geoff Dailey, Head of US and Global Thematic Equities. Welcome, Geoff, and thanks for joining me.

Geoff Dailey: Hi, Andrew. Thank you for having me.

AC: Although US small-cap stocks joined the extraordinary rally in the last quarter of 2023, many were still trading at a significant discount to their larger-cap counterparts at the start of 2024. In these final weeks of the first quarter of 2024, what’s your current view on the asset class?

GD: Small caps remain attractive. Valuations are compelling versus large caps, particularly on a price-to-earnings basis. The small-cap Russell 2000 index is trading at 65% of the large-cap Russell 1000 index, compared to a long-term average of just under 100%, so we are seeing a material relative undervaluation.

We don’t even have to close that gap entirely to see strong relative performance from small caps. The Russell 2000 is still trading at a discount, but multiples have improved since the depths of last year.

It’s important to note that while valuation is one element of the small-cap bull story, the more critical factor are the catalysts that could unlock that valuation discount. We can now see those catalysts better than we have in a while.

The first is (US Federal Reserve monetary) policy and interest rates. Easing cycles typically benefit small caps, and hiking cycles typically hurt [financial] markets; [markets are] currently calling for between two and four rate cuts this year. Macroeconomic data could push back the timing or [the number of] Fed cuts. Our base case is that we’re much closer to a Fed cut than a hike, and that’s good for small caps.

Another catalyst is the resilience of the US economy. Investors have been avoiding small caps given their recession concerns, but the economic data has been resilient and robust, and we don’t see any signs of that changing. Consumers are in a relatively healthy [financial position]. They’re employed, they have savings, wages are going up, and consumer confidence has been rising. All that allows them to spend and pay their bills.

On the corporate side, balance sheets are solid. CEO confidence is improving. In February, for the first time in two years, CEO optimism outweighed pessimism. This is a leading indicator [signalling] that companies will re-initiate halted capital spending plans and start investing for growth again. This would be good for the economy and a driver for small caps given their domestic orientation.

Another catalyst is the combination of the lower [interest] rates that we expect, boardroom optimism and economic stability. There are [signs pointing to] a more vibrant mergers & acquisitions environment. M&A has been particularly soft over the last couple of years due to tighter financial conditions and economic uncertainty. There is now a high probability that that will reverse, particularly with a healthy pipeline of deals that CEOs have lined up for strategic reasons. And M&As are always a nice tailwind for small caps. They support valuations and open the opportunities for high-premium takeouts in [our] portfolio.

We’re not completely out of the woods yet – we still keep an eye on inflation and economic data overall. We have a positive view on small caps, where we have a combination of valuation and the macroeconomic and underlying fundamentals all appearing to be coming together at the same time.

AC: Within the US small-cap segment, are there sectors or industries where you’re finding particularly compelling, idiosyncratic stock ideas?

GD: One segment where we continue to find particularly compelling risk-adjusted returns is in small-cap, innovative healthcare – either medtech or biotech companies. This is a segment that was under significant pressure in 2023, given the higher rates, tighter financing markets and generally poor sentiment on risk assets.

However, we see material scope for a re-rating of these innovative healthcare companies. The stocks are still undervalued on a multiple basis. Interest in these names, particularly biotech, is reaching a peak again. There’s still a lot of negative sentiment in the investment community, which we think could easily turn more positive and push these stocks higher.

These companies continue to innovate. They’re solving unmet clinical needs in large addressable markets. Medtech utilisation trends are strong. On biotech, the regulatory backdrop for drug approvals is accommodative. So, fundamentals and valuations are solid. We have a positive outlook.

Innovative healthcare companies are also ripe for mergers and acquisitions. Large pharmaceutical companies have lots of cash. They face patent cliffs on their drugs, so they’ll be [seeking to acquire] small caps to backfill that drug pipeline. And they often do it with big takeout premiums. So, we hope to see a healthy rebound in M&A activity, both for small caps and innovative healthcare companies in 2024 and 2025.

AC: There’s been a lot of excitement in this first quarter around artificial intelligence in selected large-cap tech names. Are you finding similarly exciting small caps that should benefit from AI?

GD: Definitely. AI has far-reaching investment implications, and not just for large caps. We’re seeing opportunities today where small caps are already benefiting from AI. We also have companies that we believe down the road will harness AI to improve their positioning.

Among some of the ways we’re playing it, one that is slightly differentiated because it’s not even a technology company – it’s an alternative asset manager that focuses on investing in digital infrastructure such as datacentres, fibre and mobile network towers. It’s a way of playing the massive investment cycle needed in digital infrastructure to support AI growth.

Another example is a security software firm, a leader in identity management. There is an increase in the number and complexity of cyberthreats to both business and governments. This cybersecurity firm is deploying its own AI to enhance its security protection products to combat these threats.

Another one is an optical networking company that we invest in, which has multiple AI applications. As AI usage increases, the world will need more bandwidth to move data from the datacentres for training, for example, and this company’s products help increase that bandwidth.

The last one I’ll touch on is a company that provides flash storage systems, both hardware and software, to improve the speed and efficiency of data storage. Its products are already used in a major tech company’s AI supercomputer, and we think it has the potential to be used in more cloud services companies’ AI applications.

There’s a considerable runway in terms of ways to play AI and small caps, and there’ll be even more ways to play it in the future.

AC: In 2023, we saw liquidity stress and talk about the high exposure of some of the smaller regional US banks to commercial real estate. Have those worries gone away or is it still something to be taken into account?

GD: It is true that small-cap banks have more exposure to commercial real estate than their larger peers. Commercial real estate credit is clearly a tail risk that we continue to monitor, and the probability of those tail risks becoming a reality gets higher if the Federal Reserve is still hiking rates. If the Fed starts cutting [rates], as we expect, it would ease the pressure on the commercial real estate market, so that would be good.

So far, small-cap bank losses in commercial real estate have been exceptionally low. We expect charge-offs to increase, particularly in office commercial real estate (CRE), but we don’t see signs of widespread systemic credit issues for a number of reasons.

First, we think banks have been relatively strong credit underwriters. Most of these loans have been underwritten at a mid-50 to 60% loan-to-value ratio. That gives banks a decent cushion for real estate prices to decline before they even realise a loss.

Diversity of loan type is also important. It’s not just office CRE that banks are exposed to – in fact, many banks have been moving away from that segment. There are healthier asset classes that banks are lending to within CRE – industrial, storage, retail, multifamily loans – that’s a diverse group of loans.

I’d point out that small caps are not financing the high-rise office towers in central business districts such as San Francisco that have seen the most pricing pressure. Small-cap banks are typically financing much smaller properties outside the major cities that have been less price volatile.

So, while we’re keeping a close eye on the commercial real estate market, we don’t see the risk as as great to small cap banks as some of the headlines suggest. In fact, we’re becoming more constructive on small-cap banks. They are relatively inexpensive, trading at 10x 2025 earnings – that’s a 25% discount to their long-term average. Compared to the broader market, banks are trading at an even steeper discount, so there’s scope for multiple expansion for banks from here.

We’re much closer to a potential positive inflection in earnings revisions. Since the beginning of 2022, small-cap bank earnings expectations for 2024 have been revised down by 25%. In a soft-landing scenario with an end to the Fed hiking cycle, we should see these earnings revisions flip [on the back of] positive loan growth. Fee income and net interest margins would improve, credit quality would be stable – these are all positives for earnings.

We are mindful of the credit risk, but in a soft-landing scenario, banks would be a good place to be given that dual tailwind of multiple expansion and positive earnings revisions.

AC: Geoff, thank you for joining me.

GD: Thank you, Andrew.