Stay-at-Home Small-Caps in Vogue as Dollar Roils MultinationalsJoseph Ciolli and Lu Wang
Like New Yorkers trying to avoid a blizzard, sometimes the best decision is to stay home. That may be the better strategy for stock investors as U.S. companies with a more domestic focus have outperformed multinationals.
Small-cap equities are having the best start to a year since 2012 relative to their more internationally diverse counterparts, and investors are taking notice. The iShares Russell 2000 exchange-traded fund tracking the index of smaller, less globally exposed stocks absorbed more than $1 billion in just four days of trading last week, while money flowed out of funds for large-cap companies.
The strongest dollar in a decade is making American goods and services more expensive overseas, eroding sales. The Dow Jones Industrial Average tumbled 1.7 percent on Tuesday as companies from Procter & Gamble Co. to DuPont Co. and Pfizer Inc. became the latest to cite the greenback’s strength as a major headwind for profits. The Russell 2000 Index, meanwhile, lost only 0.5 percent on a day in which Wall Street traders faced a spate of earnings releases following an overnight snow storm.
The outperformance in the Russell 2000 “is linked to the perception that smaller cap names have less overseas exposure,” Charles Smith, chief investment officer at Fort Pitt Capital Group Inc., which oversees about $1.7 billion, said in a phone interview. “The multinationals, the big companies, are suffering a severe currency hit.”
The 30 companies in the Dow derive about 45 percent of their sales from outside the U.S., on average, according to filings compiled by Bloomberg from firms that disclose the revenue breakdown. That compared with 16.3 percent for the Russell 2000.
The small-cap index is down 0.8 percent so far in 2015, compared to a 2.4 percent drop for the Dow. That 1.6 percent gap is the biggest to start a year since 2012, according to data compiled by Bloomberg. The small-cap gauge’s performance is a reversal from 2014, when its full-year return trailed the Standard & Poor’s 500 Index by the most since 1998.
While investors have added $1.1 billion to small-cap ETFs in 2015, they’ve pulled more than $20 billion out of large-cap funds, Bloomberg data show.
Twelve companies, or more than a third of Dow stocks, have fallen at least 10 percent from their 52-week highs. On average, they are down about 8.5 percent from recent peaks, data compiled by Bloomberg show.
P&G, the world’s biggest consumer-products maker, reported quarterly profit that missed analysts’ estimates after what Chief Executive Officer A.G. Lafley called “unprecedented” foreign-exchange rate fluctuations reduced sales by 5 percent. DuPont and drugmakers Pfizer and Bristol-Myers Squibb Co. all posted annual forecasts Tuesday that trailed predictions, in part because of the dollar.
On Monday, Bloomberg’s dollar index rose to the highest closing price since it started at the end of 2004. Even so, a trade-weighted measure of the greenback versus the currencies of its major trading partners remains short of its peaks in 2009, suggesting the dollar rally has further to go.
The greenback has taken some companies by surprise, prompting United Technologies Co. to cut an annual outlook that was just a month old.
“The strong dollar is now showing its influence on earnings for a lot of these multinationals,” Bruce Bittles, chief investment strategist at Milwaukee-based RW Baird & Co., which oversees $110 billion, said in a phone interview. “Not only do they lose their competitiveness when the dollar’s this sharp, but in translation too.”
Meanwhile, Caterpillar Inc. had the biggest plunge in more than three years on Tuesday after forecasting 2015 results that trailed estimates as plunging oil prices signal lower demand from energy companies.
For money managers like Scott Armiger of Christiana Trust, small-caps are less appealing when compared to their bigger peers because of their more unfavorable valuations. For that reason his firm, which has $6 billion under administration, favors large companies over small-caps.
The Russell 2000 is traded at 53 times reported earnings, almost three times the multiple in the S&P 500, data compiled by Bloomberg show.
In addition, smaller companies are not fully exempted from global risk as many of them are suppliers to large rivals, according to Armiger.
“There is a ripple effect on this,” Armiger, chief investment officer at Christiana Trust in Wilmington, Delaware, said in a phone interview. “There could be a lag there. If large-caps are having earnings issues right now, you can see that feeding through to the smaller companies.”
Even with the stronger dollar wreaking havoc on corporate profits, a gauge that tracks hedging in the S&P 500 has declined for the year. The Chicago Board Options Exchange Volatility Index, known as the VIX, decreased 0.1 percent to 17.23 at 9:46 a.m. in New York. The gauge is down 10 percent since the start of 2015, while the CBOE Russell 2000 Volatility Index has slipped 5.2 percent year-to-date.
For small-cap stocks to continue to attract investor interest amid relatively low volatility, the U.S. economy will have to show signs of economic growth, according to Michael Block of Rhino Trading Partners LLC.
The market is currently getting mixed signals, Block said. Data on Tuesday showed orders for business equipment unexpectedly fell in December for a fourth month, signaling a global growth slowdown is weighing on American companies.
However, last week data in the U.S. showed new residential construction rose more than forecast in December, capping the best year since 2007 and suggesting the industry will probably keep expanding this year.
“If you believe in U.S. growth, small caps should outperform,” said Block.