Advisors Favor Mid-Cap Stocks as They Outperform S&P 500 in 2024

Wall Street has been dominated by the "Magnificent Seven" stocks for the past months, but risk appetite is apparently returning to the broader market. That has some financial advisors eyeing mid-cap stocks for their clients, seeking overlooked investment opportunities.

By expanding their focus beyond the historically favored high-performing large-cap stocks, advisors are seeking to mitigate risk and enhance the resilience of client portfolios. Embracing midcap ETFs is a testament to the advisors' commitment to diversifying investment exposure and tapping into the growth potential of these often-overlooked companies.

According to Sheldon, the S&P 400's average P/E ratio from January 1997 to October 2023 was 1.04 times higher than the S&P 500's. That ratio, however, is currently only 0.68 times that of the S&P 500.

Invesco's analyst Kalivas points out that earnings projections for the next two years appear more favorable for smaller-sized companies. For 2024, while large-cap stocks are expected to see a 12.5% increase in year-over-year earnings, mid-cap stocks are predicted to experience a more substantial growth of 20.5%, with small caps leading at 29.8%. In 2025, earnings are estimated to grow by 13.9% for large caps, 17.2% for mid-caps, and 18.6% for small caps, indicating sustained momentum for the earnings of smaller companies.

"There is certainly a case that small- and midcaps are cheap relative to large-caps," said Rick Wedell, chief investment officer at RFG Advisor in Birmingham, Alabama.

Morningstar also sees small-caps as undervalued. The 350 midcap stocks covered by the investment-research firm are trading 6% below a composite of its fair-value estimates for the stocks.

Small- and mid-cap equities have performed better than large-cap stocks during the past 35 years, which has attracted investors to them.

Heritage Capital's President Paul Schatz, based in Woodbridge, Connecticut, acknowledges that the performance comparison among stocks of varying market caps is a continuous narrative. However, he notes that the current scenario stands out due to the significant and prolonged underperformance of mid-sized and small-cap stocks. He remarks that betting against large caps has been a disastrous move for many investors. Schatz suggests that the market might now be anticipating a Federal Reserve rate cut, which could invigorate investments in these underperforming market segments.

Adding industry diversity to a portfolio of large- and small-cap stocks is another benefit of midcaps. Information technology, financials, and healthcare make up the top three sector weightings in the S&P 500 with 28.9%, 13%, and 12.6%, respectively. The top three sector weightings in the Russell 2000 are industrials, at 18.3%, financials, at 16.1%, and healthcare, at 15.2%. Industrials make up 21.2% of the S&P 400, followed by financials at 16.2% and consumer discretionary at 15.8%.