Insights

After significant underperformance of small cap equities relative to large cap equities during the first half of the year, we believe small cap stocks began their recovery on both an absolute basis and relative basis to large cap stocks. Although credit market improvement year-to-date has propelled the mega cap stocks, small cap stocks have been left behind. This is an unusual occurrence in a strong credit environment, and we expect small cap stocks to catch up with large cap over the next year.

As the economy slowly begins to emerge from the pandemic, investors may naturally have concerns regarding the long term economic impact.

After a share price surge, Hertz Corporation petitioned for and initially received bankruptcy court approval to raise money via a common stock offering. This was a surprising turn of events for a company that recently filed for Chapter 11 protection. The typical bankruptcy process leaves equity holders with securities worth little to no value. Who would invest new money in a bankrupt equity?

Small value equities are valued -38% below their 10-year average, while growth, defensive, low volatility, and ESG factors exceed the bubble threshold of +30%. This dispersion has reached a 20-year high, in line with the dot-com bubble. However, bubbles can last a long time with infrequent reversion catalysts.

Equity has a credit blind spot. 95% of Russell 3000 companies issue debt, 75% of which is sub-investment grade. Equity investors study stock price movements but often ignore credit market signals. However, when a company’s credit deteriorates, its equity follows.