The first quarter brought good news for stocks, especially U.S. growth stocks. Strong economic data, healthy company earnings, and hopes for lower interest rates all fueled the market rally. However, it’s important to note that some sectors, particularly those dominated by mega-cap tech companies, may be a bit pricey at the moment.
This is a good reminder of the importance of sticking to a long-term investment plan and maintaining a diversified portfolio. Diversification helps you weather unexpected market changes by spreading your investments across different sectors and asset classes.
Innovation is the engine driving new technologies, products, and markets. While dominant firms may retain strong stock market leadership, their relative performance tends to diminish over time as competition grows. While mega-cap tech giants may continue to lead the market in the near term, valuation-conscious investors seeking diversification may find opportunities elsewhere.
Small-cap stocks have recently been out of market favor, perhaps for good reason. They are economically sensitive; they rally in recoveries and lag heading into recessions. Over the last year, small caps have lagged behind the broad U.S. equity market and haven’t benefited from trends like artificial intelligence.
Small caps are believed to offer a long-term performance advantage. Several decades ago, economists who later won the Nobel Prize identified a phenomenon known as the ‘small-cap effect.’ This theory suggests that smaller stocks compensate for their riskiness by delivering higher returns over the long run.
Lighter exposure to technology and higher exposure to “old economy” sectors, such as financials and industrials, have disadvantaged small-cap stocks relative to the market recently. As a result, small-cap stocks have not reaped the full rewards of trends like digitization and artificial intelligence.
However, we view small caps as an attractive segment based on fair value estimates. From a price/earnings perspective, small-cap stocks look cheaper relative to the market than in recent years.
Small caps could continue to underperform, and the market tech behemoths could dominate indefinitely. However, the possibility of a leadership rotation should be enough for investors to consider allocating to small caps. Valuation is a better justification for small-cap exposure than a forecast for economic growth or recovery.
With the first quarter behind us and the market performing well, it’s a great opportunity to remind you of the importance of portfolio diversification and periodic rebalancing. Diversification means having an appropriately allocated portfolio (based on your goals, investing timeline, cash flow needs, and risk tolerance) to an array of investments, including U.S. and international stocks, bonds, and cash. Rebalancing means periodically selling positions that have gained in value and become overweight to the rest of your portfolio and using the proceeds to shore up positions that have become underweight. Rebalancing at regular intervals (for instance, annually) helps keep your portfolio aligned with your original targets, leaving you better positioned when markets change direction.
At Cardinal Capital, your success is our priority. Since 1992, we’ve been a 100% employee-owned firm with a core belief: putting our clients first. Currently managing over $800 million in assets, we navigate changing markets by focusing on risk-adjusted returns. This means aiming for solid returns while carefully mitigating risk. We achieve this through diversified portfolios – a mix of investments tailored to your goals and risk tolerance.
Our investment philosophy revolves around finding high-quality companies at attractive valuations and holding them for the long term. Because we’re employee-owned, our interests are inherently aligned with yours. We’re all working towards your long-term financial well-being. If you have any questions about our approach or want a personalized portfolio review, please don’t hesitate to reach out. We are thankful for your continued trust in our firm.
Best,
Cardinal Capital Management, Inc.
