Curious about the small cap outlook in 2021? You’re not alone. Many small cap investors are looking ahead in 2021 to determine what this segment of the stock market will return to shareholders. Will it be a strong year for the smallest stocks on Wall Street? Or will the little guys lag behind bellwethers and blue chips?
To understand the trajectory of the small cap market, it’s important to look at a few variables. First, how did small caps fare in 2020—the most tumultuous year for the market since the Great Recession? Next, what factors will govern the stock market at large, and how will they affect small companies? Finally, what evidence is there to reasonably predict small cap performance in the coming months?
Researching all these topics is time intensive for investors. That’s why we’ve compiled everything you need to know about the small cap market in 2021 right here. Get a consolidated version of the small cap outlook for the year ahead.
Looking Back at Small Cap Performance in 2020
2020 may have been a volatile year for the stock market, but it was also a good one. Despite a major nosedive in March and April, the market saw a sustained, healthy recovery through the end of the year. All told, investors say returns of 16.5%, according to the S&P 500 index. Small cap investors did even better. The Russell 2000 small cap index returned a whopping 20% to investors. This was significantly higher than mid caps, which yielded a 13.7% return.
The strong performance of small caps in 2020 is even more enticing thanks to strong gains in December, which have continued into 2021. The strong uptick of small cap stocks in the early part of the year signals trust from investors as the bull market rages on.
A Positive Outlook For Small Caps in 2021
Small caps stand to benefit from investor confidence. It’s recognized that large and mega cap companies are generally overvalued. While investors still have confidence in the market, they’re looking to small caps as more accessible, value-driven investments. As a result, these companies have seen strong support—especially in hot markets like healthcare, finance and real estate. Investors are looking for the next big company and spreading the wealth to small caps poised to grow. The rise of small caps could be in its early stages.
Even in the event of market headwinds, the relative valuation (or undervalued nature) of small caps bodes well. Overvalued large cap companies have further to fall back to affordability. While unanticipated economic turmoil would disrupt the market as a whole, small caps are better-positioned to weather uncertainties.
Sectors Driving Small Cap Success
There are more drivers behind small cap success than investor sentiment. Many small cap companies have come into success in their own right, thanks to some key opportunities presented by the pandemic:
- Accessible capital: Historically low interest rates and more favorable lending practices have made it easy for small caps to access funding that might otherwise be off-limits. Moreover, a low effective corporate tax rate and opportunities for loan forgiveness have put many small cap balance sheets in a strong position.
- Recovery tailwinds: A rising tide lifts all boats. The buoyant nature of the market post-pandemic has pushed small caps to new heights. Moreover, new opportunities for market share in a shifting economy have gone to small companies with the ability to pivot.
- Cyclical surges: Small caps in cyclical industries got a major boost in late 2020. The impending threat of recession earlier in the year triggered many cyclical businesses to cycle early, which means 2021 could shape up big for companies that were aggressive during the pandemic.
- Diversification: There are roughly 13,000 small cap companies out there. Conversely, roughly 10 companies control 27% of the S&P 500 index’s value. This is to say that sheer diversity is a driving success for small caps. As investors comb these companies for value, there’s less pile-up on a core group of securities.
These factors and others will be key drivers of small cap stocks in 2021. In the current climate, there’s no reason to suggest that small caps will deviate from their current upward trajectory. That said, lots of activity surrounding small caps could pave the way for problems.
The Case Against Small Caps
The biggest argument for small cap success in 2021 is overexposure. Heavy influx of investment into small cap companies could quickly create a bubble that overinflates the market. As investors push up the value of companies beyond a reasonable P/E level, they actually begin to devalue these stocks. As quickly as they run up, these stocks could plummet due to profit-taking or fear. Overzealous investors eager to catch the next rocket to the moon could send the small cap market crashing down if they don’t temper their expectations.
Small Caps Will Outperform in 2021
When you add up all the factors listed above, it becomes clear that small caps are in for a big year. Major analysts agree. Market tailwinds favor smaller companies, and the way ahead appears free from obstructions. Of course, there’s no telling what the year will bring. The good news is that small caps are in a strong place and can adapt to market uncertainty—they’ve already proven it in 2020.
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If you’re a small cap-focused investor or have an interest in diversifying through small caps, now’s a great time to consider your portfolio. Small caps will surge in 2021, and many are already showing signs of a strong, sustainable run-up.