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Why 2025 could belong to smaller companies? · UBS Trending

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  The Magnificent Seven have captured 90% of this year's returns,
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  creating one of the most concentrated markets in history.
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  But there is a different story.
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  2025 could belong to many smaller companies
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  trading at deep discounts.
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  So the question is why?
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  And could this be the market's next big rotation.
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  We're going to talk about that right now on UBS trending.
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  Hi everyone and welcome to UBS trending.
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  I'm Anthony Pastore.
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  Thank you for joining me today.
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  Joining me for this conversation is Tom Maher.
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  He's a portfolio manager at Hilton Capital Management.
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  Tom really nice to see you.
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  Thanks for joining me.
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  And you know, we are really interested in this small and mid-cap
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  part of the story.
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  Obviously, the large caps, I mean, you know, S&P 500 etc.
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  got a lot of attention this year
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  considering that the S&P is up something like 25, 26%.
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  But our brothers and sisters in the small and mid-cap space
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  seem to have a little bit more room to grow.
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  So I guess the question that I wanted to look at with is
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  when you look at tech,
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  you look at the mag seven and all the AI stocks,
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  why should investors right now
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  be paying attention to some of those small and mid-cap names?
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  Sure.
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  Happy to be with you here today.
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  I think there's a couple of things to
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  to think about in that regard.
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  First of all,
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  you mentioned
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  that the Mag seven is now nearly a third of the S&P 500.
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  So let's say massive concentration in just a handful of stocks.
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  If you look through history and markets and I'm old enough to be
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  remembering the.com craze, those eventually do correct.
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  And when that happens oftentimes
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  parts of the market that have been left,
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  you know, left alone or left for dead
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  come back to life, they come to the fore.
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  In that case, it was value in smaller cap stocks.
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  And we think there's a couple of reasons that may happen.
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  First and foremost is simply math.
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  I mean, you have a couple of giant buckets,
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  but with most of the capital in them right now
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  in terms of equity investors,
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  if those start to move out, people start to look to broaden
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  their investments.
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  Just part of those market caps
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  coming down
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  stream are very significant to small and mid-cap stocks.
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  The second is more from a fundamental perspective.
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  If you think about a lot of the trends that we've seen,
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  sort of developing in the, in the economy,
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  you might have reshoring, you have, rebuilding us, manufacturing,
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  data center construction, a number of different trends,
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  a lot of those,
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  the ability
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  to play them directly through small
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  and mid-cap is actually very good.
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  So again, you have sort of a market phenomenon
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  that could possibly lead to,
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  better performance, broader performance and smaller mid-caps.
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  And you have some fundamental drivers
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  that I think are worth looking at as well.
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  Yeah.
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  And we'll get into that too, because, you know,
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  when you're looking at the Smid space,
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  you know, valuations look pretty rewarding right now.
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  And of course there's risk involved.
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  Because there's sort of more high
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  floating debt inside of the small cap space particularly.
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  But of course we're in this environment
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  where the fed is cutting rates.
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  And here at CIO, we expect the fed is going to cut another 125
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  basis points
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  between the next meeting in December of the fed and all of 2025.
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  And just to level set.
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  So our audience is aware here, our house view at CIO at UBS is
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  large caps have an attractive weighting while small and mid
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  have a bit of a neutral rating
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  I think because of those combinations of that floating debt
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  but also valuations.
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  So when you look at risk and reward there, Tom, what do you see
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  like what makes combining small and made in a portfolio
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  really interesting.
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  And maybe I already buried the lead here,
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  but what are your thoughts on that.
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  Yeah.
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  So obviously I think as you look to broaden your equity exposure,
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  you can think of small and mid-cap as two separate
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  asset classes, or you could look at them in one unified portfolio,
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  I think, and you hit the nail on the head from a risk perspective.
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  Combining them together, I think, actually can help you tamp down
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  some volatility relative to pure small cap portfolio.
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  So, you know,
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  that seems to be something that, you know, you're
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  you're able to get access to some of those returns.
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  But it's not as much of the volatility,
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  which might give you a little bit more of a smooth, investment,
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  performance, if you will.
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  And I think that's kind of probably the main reason
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  to think about two of them in a single portfolio.
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  The other aspect of it, I think, is,
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  if you're, you know, kind of looking at small cap stocks,
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  and you have sort of a history
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  in them fundamentally,
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  and you understand the mechanisms of those businesses,
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  if you are able to keep them as they kind of graduate
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  into the mid-cap space, you can get very nice long term returns.
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  Based on the idea that you've identified good companies early
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  and as they sort of graduate from the small class
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  small cap to the mid-cap, they can stay in the portfolio.
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  So that's another way to kind of think of it.
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  Those are kind of,
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  you know, I think broad parameters in terms of thinking about how,
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  small and mid-caps in one portfolio makes sense.
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  There's also a very sort of, you know,
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  pragmatic or practical perspective, which is,
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  that where you have, a single portfolio,
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  to, you know, kind of keep
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  an eye on as opposed to two separate ones.
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  And you can also make sure that the composition of that portfolio
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  is consistent across the whole asset class, as opposed
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  to potentially having duplication
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  between a small cap and a mid-cap portfolio.
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  Yeah, that's really that's very compelling, Tom.
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  And obviously, going back to the kind of commentary on the fed,
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  with the fed looking at cut rates as of right
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  now, throughout the rest of this year and into next year.
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  And how do these catalysts maybe set up the small
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  and mid-cap space looking into 2025?
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  Sure.
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  I think, you know, look,
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  there's a very good chance that rates will continue to come down.
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  You know, obviously we've had some volatility there, but,
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  either way,
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  I don't think we're expecting them to go back to zero again, which,
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  you know,
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  we've had this long run here
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  where large cap stocks have outperformed small and mid-cap,
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  which is actually,
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  contrary to the longer arc of investment history.
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  And I think, as we go forward, I think rates may be
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  a little more accommodative,
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  but again, likely not going back to zero.
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  If you think about the small and mid-cap space,
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  what's going on in the economy,
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  if we have continued sort of development
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  of the domestic economy, even if it's slowed down a little bit?
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  Those are great opportunities for a lot of these companies.
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  And, you know,
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  through small and mid-caps,
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  you can play against some of those trends directly.
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  They tend to be less diversified to some extent.
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  The smaller companies.
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  So it's important
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  to have, sort of,
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  thoughtfulness in terms of how you put that portfolio together.
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  But, you know, we look at,
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  you know, what's
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  relatively a constructive backdrop, for equities at this point,
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  and what looks like a sort of somewhat forgotten asset
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  class that adds up to probably opportunity.
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  And you layer on top of that
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  what looks like some identifiable business trends, again,
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  that the small caps can really kind of directly, exploit.
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  It could be a nice thing to add to a broader equity portfolio.
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  Absolutely.
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  I mean, clearly we you know, we always say hear from our CIO
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  and UBS that diversity really is key in any successful portfolio.
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  And working with a financial advisor is the way to do that.
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  But, you know, you're looking at sort of risk management,
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  especially when you're in the small cap space,
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  particularly especially pure
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  small cap play,
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  because there's a lot of,
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  companies that are really not profitable in there.
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  And then you also have these high floating debt rates, etc..
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  So how do you approach risk management in this space and tell us,
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  give us the sort of the, the,
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  the real reasons or the reasons why active management
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  right now makes more sense than passive, especially in Smid?
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  Absolutely.
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  I think,
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  as you come down
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  cap range,
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  a few things come to mind that makes it in our, in my perspective,
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  kind of interesting to consider, an active approach
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  as opposed to a passive or an index approach.
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  First and foremost is as you move down cap,
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  some of these companies are not as over
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  followed as some of the mega cap or large cap stocks.
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  To me, that speaks of some, inefficiencies.
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  And if somebody has done
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  some good active fundamental research,
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  you can identify companies with better prospects.
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  You're going to want
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  to populate the portfolio with those stocks over anything else.
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  Secondly, and you mentioned this,
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  if you look at the small and mid-cap space combined, it's something
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  in the neighborhood of 20% of those companies are non earners.
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  If you look at small cap it's even higher than that.
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  So if you're just going to buy it via
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  a passive vehicle, you have to be sort of buyer beware.
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  You have to know what's in that portfolio.
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  A lot of those stocks,
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  may have issues in terms of self-funding their growth.
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  And if, if conditions
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  kind of change, it's going to get harder for them.
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  So once again,
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  I think,
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  an active management approach
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  where you keep an eye
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  on on the quality of the stocks in the portfolio,
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  probably makes sense in this space.
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  I think also, look, we've talked about there's a pretty,
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  constructive backdrop out there, but there's certainly uncertainty.
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  We just had a big election.
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  Interest rates, you know, have moved down
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  but then moved up a little bit.
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  It's unclear, you know, the exact path forward.
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  And obviously the growth rate in the economy,
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  we're not sure where that's going to pan out.
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  Again, all of those things, I think, lead to the idea
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  that this space, while it does provide opportunity,
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  probably makes sense to look at it from an active lens,
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  where somebody is sort of,
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  you know, very carefully picking, your exposure in the space.
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  Excellent, Tom. Thank you.
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  It's a really compelling story,
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  especially given that small caps right
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  now, valuations are really attractive versus large cap.
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  So it kind of suggests that maybe they could potentially outperform
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  large caps over a certain time horizon.
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  So it's a really good time for folks
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  to be kind of looking into how to diversify their portfolios.
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  And yeah,
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  an active approach certainly makes sense
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  given the context of what you just talked about with us.
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  Tom, thanks very much. Great rundown for us.
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  Thanks very much.
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  It's really good to have you.
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  Tom Maher from Hilton Capital Management,
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  and thank you all for joining us.
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  There's lots more information on this topic
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  and more by visiting our insights website at ubs.com/views.
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  Give us a follow right there. It's right on your screen.
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  And as always,
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  if you have any questions about this topic or any others,
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  make sure you are speaking with your financial advisor.
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  Until next time. I'm Anthony Pastore.
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  Have a great rest of your day
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  and remember to keep your eyes on what's trending.
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  See you soon everybody!