What do current valuations say about small-cap stocks?
June 22, 2012
Small-cap price-to-earnings (P/E) valuations have maintained slightly above-average ratios during the past several quarters. We believe small-cap stocks have benefited from a combination of strong earnings in a modestly growing economy and a very accommodative U.S. Federal Reserve that seems intent on keeping short-term interest rates low for an extended period. In our view, the biggest potential headwind for small-cap equities would be a significant slowdown in the U.S. economy.
In this recovery, small-cap stocks have followed a performance pattern similar to that of past recoveries. The first two years following the stock market bottom in March 2009 saw small-caps lead market returns, while 2011 saw a reversal as large-cap stocks assumed the leadership position. Given the relative valuations of small-cap versus large-cap equities, we do not expect a dramatic outperformance by one asset class over the other in 2012. One of the major reasons for this expectation is that the ongoing recovery is likely to remain subpar (by historical standards) due to the weak, but slowly improving, housing market.
Currently, there does appear to be some complacency regarding overall valuations. Investors who are more negative on small-caps tend to have fears of a significant European debt problem adversely affecting the U.S. economy, or a slippage of the still somewhat fragile housing recovery.
Investors such as ourselves, who acknowledge that valuations are slightly above normal but still appear reasonable, tend to point to the strong earnings reports, solid balance sheets, and extremely low interest rates as reasons to be more optimistic. Of course, if any of these positive factors were to reverse, it’s likely that the performance of small-caps would struggle.
We believe there has been a renewed interest in small-caps, based on a recent change in fund flows. After witnessing several years of outflows, we have seen modest but steady inflows back into small-caps, including Delaware Small Cap Value strategy, through the first quarter of 2012. We believe it is possible that a subtle shift out of fixed income assets and into various equity classes has begun, and may very well continue, based on the Fed’s statements that it has no intention of raising interest rates in the near term. Additionally, we believe a significant shift from fixed income assets into equities may possibly assist in the performance of small-cap equities.
The portfolio management team of Delaware Small Cap Value strategy seeks consistent long-term performance by investing in small-cap companies. The team adheres to a traditional value-oriented investment philosophy and employs a rigorous analytical process to identify what it views as attractive stocks.
The views expressed represent the Manager’s assessment of the market environment as of June 2012, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager’s current views.
Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting delawarefunds.com/literature or calling 800 362-7500. Investors should read the prospectuses and the summary prospectuses carefully before investing.
IMPORTANT RISK CONSIDERATIONS
Investing involves risk, including the possible loss of principal.
Investments in small and/or medium-sized companies typically exhibit greater risk and higher volatility than larger, more established companies.
The price-to-earnings ratio is a valuation ratio of a company’s current share price compared to its earnings per share.