Style and market capitalization allocation within equities will be important as we believe a rotation to value-style equities is underway and small caps are set to continue recent outperformance. Growth-style equities, particularly those companies with negative current cash flows and the expectations of positive future cash flows, have experienced volatility. Similar to longer duration bonds, the distant projected positive cash flows of growth companies are discounted more severely in a rate rising environment. This dynamic negatively impacts the net present value of growth companies (read as share price declines).
Conversely, value-style equities have held up relatively well and are leading growth-style investments for the year-to-date period. Value’s dominance is driven in part by the deployment of vaccines and the lifting of mobility and activity restrictions across the country. Additionally, earnings valuations of value-style indices entered the year far below that of growth-style indices, which provides a better entry point relative to growth-style indices and is compounded by the strong earning growth projections of value-style companies.
We expect small and midcap stocks (SMID) to perform well in 2021 as they have historically performed well during economic recoveries. As we collectively begin to see the pandemic in the rearview mirror and Washington implements the $1.9 trillion American Rescue Plan Act of 2021, we expect SMID caps to perform admirably.