Citi Gives 3 Reasons Investors Should Shift to Smaller Stocks

• Citi analysts say smaller stocks may be poised to outperform amid the low earnings bar.
• Smaller stocks may also hedge against risks related to a Trump presidency.
• “In our view, lowering the cap in pursuit of alpha opportunities could help manage certain risks,” Citi said.

Citi analysts said inflows into small-cap stocks have tapered off in recent weeks following this summer’s rally, but the under-the-radar part of the market may be poised to outperform in coming months.

Analysts point to a range of factors, from a low earnings bar to factors related to Donald Trump’s potential victory, that point to an impending rally for small-cap companies.

Analysts said smaller stocks have a lower bar for earnings growth, making it easier for them to impress Wall Street when they report results.

They say small- and mid-cap stocks are pricing in 2% to 10% growth in earnings per share over the next three years, while the S&P 500 is expected to post 15% to 22% growth in earnings per share.

“While earnings surprises have been stronger so far in Q3 reports, larger or similar percentage beats in certain Small/Midcap sectors/names may be more rewarded by markets given a lower bar for results,” analysts said. “Driven by the Magnificent 7, the S&P 500 may need stronger results and forward forecast revisions to confirm current levels.”

Second, smaller stocks can hedge the risks associated with a second presidency of Donald Trump.

Trump proposes sweeping 20 percent tariffs on all imports and tariffs 60% or more on goods from China. Small-cap companies have historically been hedged against risks related to tariffs, analysts said.

They noted how small-caps initially performed better after his surprise victory in 2016 and again after he imposed steel tariffs in his first term.

“In both cases, Small/Mid Cap increased relative outperformance when economic data came in weaker than expected,” analysts said.

Analysts also say that if Trump wins, the market does not expect much power from small caps, which means there will be more room to maneuver.

“Conversely, Small/Mid Cap, with low implicit growth expectations, may be, to some extent, a Trump trade that is relatively underpriced at current levels,” they said.

Finally, their third point was that smaller caps are generally less liquid, but focusing on smaller names could be a trade-off when considering opportunities.

“The impressive Large Cap performance has clearly created some hesitancy to lower the capital cap and, in turn, has driven down liquidity. In our view, lowering the cap to explore alpha opportunities could help manage certain risks and provide investors with a trade-off for lower liquidity.” “It may offer the opportunity to Büyük,” said analysts.