Small-Cap Frenzy Boosts Emerging Markets by $318 Billion

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Small-Cap Boom in Emerging Markets

As 2023 nears its end, a winning investment strategy in emerging markets is unveiled: investing in small-cap stocks. These smaller companies have yielded a remarkable 12% more gain than the MSCI large-cap index this year, marking the second-best relative returns in the past 14 years. Investors attribute the surge in small-cap investments to the resilience of these companies against China’s economic challenges, a quality not shared by larger corporations.

Local Growth and Technological Hype

Small-cap stocks are reaping the benefits of local growth narratives, especially in countries like India. Additionally, the enthusiastic investment in young companies focused on artificial intelligence and electric vehicles is fueling this surge. These factors have propelled small-caps, outperforming large-caps consistently since emerging from the Covid drawdown.

Noteworthy Gains by Individual Stocks

Several individual small-cap stocks have witnessed impressive returns. For instance, companies like Taiwan’s Wistron Corp. and Global Unichip Corp. have seen substantial surges due to their involvement in artificial intelligence development. Similarly, stocks like Jindal Stainless Ltd. and Rail Vikas Nigam Ltd. have gained significantly, riding India’s booming economy, one of the fastest-growing among major economies.

Country Skew and Performance

The outperformance of small caps over large caps in emerging markets can be largely attributed to country skew. China’s dominance in the large-cap index affects its overall performance. However, those who have strategically diversified their portfolios by prioritizing India, Taiwan, and Korea over China have seen substantial gains.

Balancing High Returns and Risk

High returns may be enticing, but investors often sell off small-cap stocks in emerging markets first when risk sentiment declines due to their inherent volatility. They have historically underperformed during crises, highlighting the risk associated with them. Factors like lower regulation, political interference, and governance issues further add to the risk for investors in the small-cap sector.

Future Prospects: Central Bank Influence

For small-cap stocks with sound management and a solid business plan, the next potential boost could come from central banks considering interest rate cuts. Lower borrowing costs significantly benefit small caps, as they often rely more heavily on debt financing than their large-cap counterparts. This could extend their outperformance and offset concerns regarding China’s economic slowdown impacting larger stocks.

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