US STOCKS: Visa, Honeywell rise * Amazon, Facebook, Alphabet results awaited this week * Indexes down: Dow 0.24pc, S&P 0.12pc, Nasdaq 0.09pc -
NEW YORK: Optimism is souring around small-cap stocks for some investors, with a host of factors conspiring to up-end gains that have taken them to record highs.
Small-caps, which led the market’s rally just after the November 8 election of Donald Trump as US president, are facing weak earnings forecasts, little progress on tax reform and recent outflows.
“We have downside risk here. Earnings numbers aren’t great, and valuations are... pretty rich,” said Steven DeSanctis, Equity Strategist at Jefferies.
Investors had expected the administration of Republican Trump, with his promises of aggressive tax cuts and a healthier US economy, would be a boon for small-caps, which tend to be more domestically focused.
Republicans so far have been unable to push through bills to repeal and replace the Affordable Care Act, the first leg of the Trump agenda. That has raised doubts about the likelihood of any tax reform this year. Small-caps have higher effective tax rates — about 32 per cent versus 26 per cent for large-caps, a note from Nuveen Asset Management showed.
All three indexes hit record highs in recent sessions, just as the earnings reporting period was getting under way.
But analysts estimate earnings for S&P 600 companies declined 8.3 per cent in the second quarter, dragged down by projected drops in consumer discretionary, energy and healthcare results, according to Thomson Reuters data. Revenue is expected to have risen slightly in the quarter.
Among consumer companies, weakness in apparel, accessories and luxury goods and other retailers is expected to have hurt results, said David Aurelio, Thomson Reuters senior research analyst.
In the small-cap energy sector, services and equipment companies continue to be affected by project cutbacks by larger companies.
The small-cap outlook is in contrast to expectations for another quarter of strong profit growth for the S&P 500 and a sharp year-over-year jump in large-cap energy.
“Small-cap earnings growth has been trailing large-caps for the last four years, and that continues to be the case in the first half of this year,” said Dan Suzuki, senior US equity strategist at Bank of America Merrill Lynch in New York.
That does not bode well for valuation metrics for small-caps, which the bank calls “the most expensive segment of an expensive market.”
The Russell 2000 is trading at about 26 times forward earnings as per Thomson Reuters Datastream data, above a median of about 21. The S&P 500 trades at about 17.3 times, also above its median. While analysts expect small-cap earnings to rebound in the second half of the year, some strategists said those lofty expectations are not likely to hold since US economic growth remains sluggish.
Large-caps have benefited from recent weakness in the US dollar, which makes foreign currency earnings for US companies worth more in dollars.
Recent fund data also shows a weakening trend. According to Lipper, US-based small-cap funds have recorded five straight weeks of withdrawals.
At the same time, technical momentum indicators are trailing the Russell 2000’s recent push to new highs, a possible warning that its foray into record territory is on less than firm footing.
“We’re in a longer period of underperformance,” Suzuki said.
US STOCKS: US stock indexes pared losses, helped by a rise in Visa in early afternoon trading on Friday, but weak earnings from industrial heavyweight General Electric weighed.
Shares of GE fell as much as 5.4 per cent to their lowest level since October 2015, as the company reported a nearly 60 per cent slump in profit and its 2017 profit forecast came in at the low end.
The stock’s fall weighed on other industrials such as Caterpillar and 3M.
Visa rose 1.8 per cent after the world’s largest payments network operator raised its annual earnings forecast. The stock was the top boost on the Dow and the S&P.
Microsoft fell 0.7 per cent, despite the company reporting strong fourth-quarter earnings.
Attention will turn to earnings from big tech names next week, including Amazon, Alphabet and Facebook .
The Nasdaq came off its 10-day streak of gains, its best since February 2015, after closing at record levels on Thursday.
The tech sector, however, continues to be the best performing S&P sector this year, despite concerns over stretched valuation, as investors look for growth from sectors relatively immune to a policy gridlock in Washington.
The Dow Jones Industrial Average was down 52.63 points, or 0.24 per cent, at 21,559.15, the S&P 500 was down 2.98 points, or 0.12 per cent, at 2,470.47.
The Nasdaq Composite was down 5.61 points, or 0.09 per cent, at 6,384.39.
A rise in Netflix and biotech stocks Celgene and Gilead helped limit losses on the tech-heavy index.
The S&P and the Nasdaq are on track to close higher for the third straight week. Nine of the 11 major S&P sectors were lower, with the industrials and energy sectors leading the decliners.
— Reuters
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