Stock Market Insights: Scaling back large-cap growth for small-cap opportunities

DR. RICHARD BAKER, AIF®, is the founder of and an executive wealth advisor at Fervent Wealth Management. https://www.facebook.com/DrRichardBaker

We had been catching some white bass, but the bite went cold. I asked my Poppy what we should do, and he said, “We clean today’s fish and come back to see what they’re biting on tomorrow.” We didn’t have enough fish for our fish fry yet, but it was a good start. Sometimes, when we didn’t have a “mess of fish,” we’d turn the fish we caught free and try again another day. This time, Poppy felt certain we’d do well again the next day and saved the fillets for later. Sometimes, you have to do the same thing when investing.

Large-cap growth stocks (such as Microsoft, Amazon and Meta) have had quite a run in the last few months. The large growth style is up almost 10% this year and 43% in 2023, based on the Russell 1000 Growth Index. I think it's time to take some of those gains.

This strong run that out-performed the rest of the market, along with their high valuations, is why I’m reducing my client’s large-cap growth back to my neutral setting from the previous overweight. This will lock in some of the gains and free up some cash to shift to the opportunities in high-quality small-cap stocks, which I think offer a better risk reward now.

Large cap growth might be slowing down.

So why sell some of the large-cap growth stocks that are performing so well? The main reason is to lock in gains in case of a short-term pullback.

Besides locking in profits, the asset class has become overbought leading it to peak and show signs of slowing momentum. My opinion is that these stocks were being pushed by investors being overly optimistic about potential profits from artificial intelligence software.

I still like the large-cap growth sector because it gives my clients exposure to high-quality companies with great earnings. This is why I’m trimming my exposure and not eliminating it. Small cap stocks could be due for a catch-up rally In looking for an asset class to move to after reducing large-cap growth, I considered international equities and even fixed-income. I landed on small caps, increasing my exposure to a neutral stance from underweight.

Although small caps have yet to outpace large caps, they could be due for a catch-up rally over the coming months, and I want to get my clients positioned before they do. The outlook for small caps is good because of low valuations for high-quality (profitable) small caps and the belief that the market will broaden beyond large caps, boosting small and mid-caps.

In early spring, the white bass make their spawning run from the lake up the rivers and creeks. Growing up in a river town made this our favorite fishing time of the year, but white bass are finicky. Any slight change in the weather could turn them off. Sometimes, you’d catch enough to feed your whole family, but other times, you’d only catch a few. In those times, much like investing, you caught the amount you needed at different times. So don’t be afraid to put your profits and fish fillets where you can use them another time.

Have a blessed week!

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