A chief Wall Street strategist said that consider buying cheap “ powerful microcap ” stocks, which have done even better than their large-cap peers since the coronavirus crash

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• Microcap stocks behave just as well as some investors’ preferred choices, but at much cheaper valuations, said James Paulsen, chief investment strategist at The Leuthold Group, in a note.
• The “powerful microcaps” outperformed their tech peers and even the S&P 500 growth index, although growth names typically gain the most after a bearish fall.
• The smaller of the smaller stocks are also trading at record valuations against the S&P 500, Paulsen noted.
• If microcaps continue to keep pace with their larger counterparts, “investors should consider diversifying a portion of their S&P 500 allocation,” the strategist said.
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An unexpected stock pool behaves almost as well as hugely crowded tech giants, and investors can still enter at cheap levels, according to a top strategist.

Investors have largely overlooked microcap stocks – the smallest of the small public companies – since the indices hit a low in March. This trend is not new. After such a sharp collapse, investors typically crowd into big names in growth and bet on their healthy cash flow to increase their chances of surviving an economic downturn.

Yet the smaller stocks in the market are performing almost as well as the S&P 500 and are going against the historical trend, said James Paulsen, chief investment strategist at The Leuthold Group, in a note to clients. The “powerful microcaps” have significantly outperformed the Russell 2000 Small Cap Index, from the market peak February 19 to August 11, the strategist found. The subset only underperformed the S&P 500 by 2%.

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Still, microcap growth stocks are beating their larger peers at their own game, Paulsen said. The Russell Microcap Growth Index jumped 7.2% over the same period, ahead of the 6.7% gain in the S&P 500 Growth Index. Small-cap growth stocks lost 0.8%.

At the other end of the equity spectrum, value microcaps performed in line with the S&P 500 Value Index. Both indicators beat the Russell 2000 Small Cap Value Index.

The Leuthold Group

Investor interest in tech stocks has boosted microcaps even more than the most popular names. The Russell Microcap Technology Index gained 11.1% on the market rally, beating the 8.6% advance of the S&P 500 Tech Index.

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“Much of the attention this year has been on AAPL, GOOG, NFLX, FB, and TSLA. But, have you heard of OSTK, SRNE, APPS or MAXR?” Paulsen said. “If the Micros can really keep pace with the Bigs, investors should consider diversifying a portion of their S&P 500 allocation.”

Paulsen maintains that it is not yet too late to do so. At the end of 2018, the valuation of microcaps against the S&P 500 was about the same as the relative valuation of small caps at around 0.75.

Yet the two have drifted away from each other throughout the pandemic. While the valuation of small caps against the S&P 500 sits just above 0.5, the valuation of microcaps has fallen this year to a record low of 0.3. This level implies a historic low price in the stock surge and prepares them for larger gains if investors find out their value.

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If microcap stocks continue to rise at the same rate as the most favored growth names in the market, “they will eventually be discovered,” Paulsen said.

“Who knows, maybe these Mighty Macros will one day have an acronym?” he added.

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