asset allocation  |  july 7, 2020

Seeking Upside Potential

Small-caps may offer better upside potential than value stocks.


Key Points

  • Given the disconnect between the stock market rally and the deep economic impacts of the coronavirus pandemic, we have reduced our allocation to equities.

  • We are seeking upside potential in small-cap stocks, while limiting exposure to value stocks.

Tim Murray, CFA

Capital Markets Strategist, Multi‑Asset Division

The stock market rally has moderated recently, but we believe a large disconnect remains between the rebound and the deep economic impacts of the coronavirus pandemic. Given the uncertain upside potential for stocks, we reduced the allocation to equities in our multi-asset portfolios from an overweight to neutral.

Year-to-date performance among U.S. equities has varied widely. Large-cap and growth stocks have, for the most part, regained their losses. However, small-cap and value stocks, which are more vulnerable to economic weakness and typically have more debt, have lagged—resulting in attractive valuations with embedded upside opportunity but greater risk.

We have chosen to overweight small-caps but not value stocks primarily because we prefer cyclical risk over secular risk. A full recovery may take a while, but we believe that cyclical forces could benefit small-caps as the economic environment improves. Conversely, secular forces that have driven equity returns over the past decade, especially within technology, have become more pronounced, and the low interest rates that have plagued financials stocks are likely to persist. These factors present significant challenges for value stocks.

For a historical perspective, after the global financial crisis—when stocks in the financials sector were weighed down by both low rates and increased regulation while technology stocks benefited from the initial stages of online adoption—small-caps outperformed, benefiting from their balanced sector exposure. However, value stocks did not.

Therefore, as the U.S. economy rebounds from recession, we believe that small-cap equities may offer a better opportunity for upside potential than value stocks.

Uncovering Opportunities

A closer look at equity performance

2 charts - First line chart shows the year-to-date performance as of 6/22/20 where total returns totaled: S&P 500 Growth Index at 6.99; S&P 500 Index (large-cap) at -3.19; S&P 500 Value Index at -14.67; ; and S&P Smallcap 600 Index at -19.21. The 2nd line chart shows where the S&P Smallcap 600 Index less S&P 500 Index and S&P 500 Value Index less S&P 500 Growth Index stands in terms of cumulative performance difference % from 2009 to 2014 (following the 2008/2009 recession).

Past performance is not a reliable indicator of future performance.
Sources: Standard & Poor’s (see Additional Disclosures). T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved. Haver Analytics/Standard & Poor’s.

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Additional Disclosure

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The “S&P 500,” “S&P 600,”“S&P 500 Growth,” and “S&P 500 Value” are products of S&P Dow Jones Indices LLC, a division of S&P Global, or its affiliates (“SPDJI”), and has been licensed for use by T. Rowe Price. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”). T. Rowe Price is not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the The “S&P 500,” “S&P 600,”“S&P 500 Growth,” and “S&P 500 Value.”

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of July 2020 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.

Information and opinions presented, including any forward-looking statements, have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. Actual outcomes may differ from any forward-looking statements made.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Small-cap stocks have generally been more volatile in price than the large-cap stocks. All charts and tables are shown for illustrative purposes only.



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