A massive reversal of momentum favoring small-cap stocks over large-cap stocks is likely to continue, according to Goldman Sachs strategists.
Last week, small-caps recorded a historic weekly performance against large-caps, which is attributed to several factors, including a slowdown in inflation and the anticipation that the Federal Reserve may lower interest rates in September.
Furthermore, consistent economic growth data and a surge in the likelihood of a Republican majority in upcoming elections have contributed to this reversal.
“Small caps tend to be very sensitive to the US economic growth environment, and they strongly outperformed following Trump’s 2016 election. Small caps are also more domestic-facing than large caps and less vulnerable to tariffs,” the analysts wrote in a report.
The investment banking giant also noted a compression in the earnings per share (EPS) growth premium of large-cap stocks relative to their smaller peers as a significant factor.
“The recent trend of small-cap outperformance will likely persist unless the macro environment changes substantially, or the mega-cap Tech stocks report 2Q results that causes analysts to raise revenue forecasts for the next several quarters.”
The report also highlighted that investors are showing concern regarding the sales projections for large technology firms, known as hyperscalers.
“[I]nvestors have become increasingly concerned about the prospect of “overinvestment” in AI, especially among the four hyperscalers (AMZN, META (NASDAQ:), MSFT, and GOOGL).
“[These firms during the past six months have dramatically increased their planned spending on AI initiatives but it is not apparent when the return will come – in 2027, 2028, 2029, or perhaps not at all?”
This lack of growth in sales estimates is seen as a potential limiter to the performance of these large-cap tech stocks.
“The potential resumption of the AI trade – and by extension a reversal of the recent underperformance of large-caps vs. small-caps – will depend on revenue revisions.
” outperformance will resume if big Tech beats and raises its forward sales guidance. If not, then small caps will continue to outperform,” the brokerage firm concluded.