3 in 3: Small Caps’ Window, Energy’s Edge, Defense’s Disconnect

Small caps offer a more attractive entry point, energy combines strong cash generation with low valuation, and defense stocks appear mispriced after major contract wins.

• Through the end of August, the US small-cap index traded at about 28 times forward earnings, roughly a four-turn premium to its five-year average.
• Excluding the 2022 rate shock from that average, small-cap multiples are roughly in line with historical levels, while two-thirds of companies beat Street expectations—the highest proportion in more than five years.
• Energy has been the best-performing sector this year across large and small caps, yet it trades at the lowest EV-to-EBITDA multiple in the S&P and offers the highest free-cash-flow yield.
• Energy companies are returning substantial cash through dividends and buybacks, and oil-market uncertainty raises both the sector’s risk premium and the value of shareholder distributions.
• Defense stocks are down year to date despite broad markets and industrials being up, even as companies have won some of the largest defense contracts in years, with certain awards securing work for the next decade.

Takeaway: Voya is leaning into small caps and defense stocks and remains constructive on energy, while acknowledging that higher manufacturing costs could pressure defense margins in the near term.