Small-Cap Value Set To Outperform

  1. Buybacks are a key part of our macro equity framework. Buybacks are supported by free cash flows and cheap debt. This is why the below chart is so important. Buybacks have been anemic year-to-date, but with aggregate SPX FCF up 20% YoY we should see that trend start to reverse over the next two quarters (chart from UBS).

  1. These are very interesting charts from UBS. The chart on the left shows the population growth by cohort (35-55 and 65+) on a YoY basis. As you can see, the 35-55 age group is inflecting higher while retiree growth has peaked and is set to rapidly slow. This is important because the younger cohort tends to own more equities as a % of investment versus the 65+ group which is more heavily weighted towards less risky assets.

The chart on the right shows the correlation between the growth difference of the two cohorts (gold line) and the equity risk premium (blue). If this correlation continues to hold then we should see the equity risk premium — which is currently well above its long-term average — narrow significantly. And since the Fed is unlikely to let yields rise, that means higher equity valuations are in order.

  1. The last two months I’ve been making the bull case for small-cap outperformance. Here’s a chart from UBS showing the connection between relative small-cap/SPX dividend yields and performance… If history is any guide, we should see small-caps step on the gas soon.

  1. Small-cap value is my favorite place to look for names right now as both factors should continue to materially outperform over the coming quarters.

(Click on image to enlarge)

  1. I’m not convinced that we’re going to see a secular turning point in relative performance though. That would require a sustainable jump in inflation and a steepening of the curve. But we should at the least see a tradeable multi-month reversion play.
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Disclaimer: All statements are solely opinions and are for educational purposes only.

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