- US small-caps look cheap relative to the S&P 500 index and may offer some diversification
- Funds focused on this area have delivered strong returns
- But they can be very volatile
For all the talk of market rotations, 2021 has ended with a set of questions already painfully familiar to investors. Is the S&P 500 index now overvalued after a strong year and can it continue its stellar gains? This index again outpaced other major regional markets in 2021, but these gains are accompanied by fresh concerns that such returns have been driven by a handful of large tech stocks. From monetary tightening to any new Covid-19 developments, other events could put the world’s leading market off course in 2022.
So investors are yet again considering potential diversifiers to S&P 500 exposure. Different equity regions and asset classes can provide part of the answer. But there may be a way to do this while remaining invested in the US market. The Financial Times recently reported that the S&P 600, an index tracking the small-cap segment of the US market, was trading on a much lower forward price/earnings ratio than the S&P 500, putting smaller companies at a “historic discount” to bigger stocks. That reflects a gap in the performance of the two: the S&P 500 generated a sterling total return more than double that of the Russell 2000 between 1 January and 20 December 2021.