Valuation disconnect may present small-cap opportunities in 2025

Published 23/12/2024, 02:20 pm
© Reuters.  Valuation disconnect may present small-cap opportunities in 2025
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Investors Mutual expects 2025 to present substantial opportunities within the small-cap sector, citing a "valuation disconnect" between larger and smaller ASX-listed companies.

Senior portfolio manager Simon Conn anticipates increased attention on smaller stocks in the coming year, alongside expectations of one or two interest rate cuts by the RBA as inflation remains relatively high, particularly in services, citing wage growth and electricity prices as concerns.

Conn added that government spending was another contributing factor and said, "It's pretty unlikely the government suddenly will stop spending in the lead-up to an election."

“The backdrop is not showing a consumer-based recovery, it’s not a cyclical recovery, it’s just sort of a slow grind.”

Despite investor concerns over potential fewer rate cuts in the United States, which have led to selling pressures, Conn observed that the small to mid-cap sector had been "a bit unloved and less researched”.

Conn believes this scenario offers ample opportunities for stock pickers, stating, "We own some stocks that trade at big discounts to their large cap peers and it's just a valuation disconnect."

Companies such as financial services group ClearView and transport firm Lindsay Australia are highlighted as examples.

Interest rate uncertainty

Wilson Asset Management lead portfolio manager Oscar Oberg supports this outlook and remains optimistic about small-cap stocks entering 2025.

Oberg references the 17% total return of US small caps (S&P 600) over the past six months, outperforming large caps by nearly 6% following anticipated interest rate cuts.

Oberg forecasts an RBA rate cut around March or April 2025, with additional cuts throughout the year, suggesting a potential tailwind for Australian small caps.

However, investors were hesitant last week, expecting fewer US rate cuts next year.

The US Federal Reserve opted to cut its benchmark policy rate by 25 basis points to a target range of 4.25%-4.50%.

While this met market expectations, updated economic projections from the Federal Open Market Committee (FOMC) pointed to an expected economic slowdown next year, with the suggestion of a slower pace of cuts in 2025. It now expects only two rate reductions expected next year, down from the four previously forecast.

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