The SMID-cap revival looks set to continue

Developed-market SMID stocks should continue to outperform large caps in the coming months and years, although near-term returns may be volatile as macroeconomic risks remain elevated.

• As of September 16, the Russell 2500 was up approximately 16% year to date, versus about 10% for the S&P 500; the rebound is concentrated in developed markets, while emerging-market SMID stocks have underperformed.
• Fundamentals are improving because wage inflation is easing and rate moves are less severe than in 2022–23; 82% of large-cap debt is fixed, compared with nearly 40% of SMID debt floating and already marked to market.
• Positioning remains depressed after four years of outflows from developed-market SMID stocks, with cumulative withdrawals exceeding Global Financial Crisis levels in parts of the U.K. and continental Europe.
• Relative performance and technical indicators remain unusually weak: the recent underperformance versus large caps has only been exceeded once before, during the technology bubble, after which SMID stocks outperformed for 14 years.
• Domestic revenues, lower foreign-exchange exposure and political insulation support SMID stocks amid deglobalization, while their valuation discount to large caps remains historically extreme; J.P. Morgan defines small caps as below $2.575 billion and mid caps as $2.575–$12.85 billion in market capitalization.

Takeaway: J.P. Morgan remains positive on SMID stocks relative to large caps and favors selective U.S. and European companies with achievable estimates, undemanding valuations and visible earnings, but warns that higher rates, oil near $100 per barrel, a possible super El Niño and expensive or leaderless sectors could make the rally stall.