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Australian investors have shown interest in ASX small-cap shares in recent weeks amid a sharp correction in the broader markets.
Like us entered the new financial year, S&P/ASX Small Ordinaries Index (ASX: XSO) rose 4.6% to a high of 3,087 points on July 17.
Meanwhile, big cap S&P/ASX 200 Index (ASX: XJO) rose just over 4% and hit an all-time high of over 8,000 points a day later.
Many are concerned about a supposed rotation from large-cap stocks to the smaller end of the market as a possible sign that the market may be slowing. That may or may not be true – both indexes for large-cap and small-cap stocks are down about 2% in the past week.
Let’s take a closer look.
Time to consider small-cap ASX shares?
Some fund managers believe that potential interest rate cuts could boost small-cap growth. With speculation that the US Federal Reserve could start cutting interest rates as early as September, investors are already repositioning portfolios.
Fidelity Australia’s Lukasz de Pourbaix notes that market confidence is shifting from mega-caps to smaller-cap stocks. This is driven by the forecast of controlled inflation and rate cuts. According to Australian Financial Reviewsaid the specialist:
The market is a little more confident that we can see rate cuts and that the inflation journey in the US is under control.
So we’re seeing the market pivot from those mega-caps, which are considered the safest parts of the market, as there’s now a bit more confidence to come down the market cap spectrum.
While the trend is evident globally, ASX small-cap stocks have lagged behind their large-cap counterparts in recent weeks.
But this has not prevented many funds. Firetrail Investments cautions investors not to wait too long, stating that small caps tend to recover before the economy reaches its limit. Portfolio manager Eleanor Swanson told the AFR:
Small caps tend to take six to nine months before we see the economy swing and we all know it’s pretty tough in Australia, especially for consumers.
But by the time we get a sign that the RBA is cutting … it’s already too late to get into small-cap stocks. You really need to be there before the economy crashes.
Where are the opportunities?
The question is, where do you start looking? Hyperion Asset Management has several indicators. He suggests that investing in small caps with low debt loads and growth potential could be the way to go – even in “rising rate markets”.
If you can identify those really high-quality businesses that are the leaders of the future and have a disciplined approach to investing in them, it can be a really, really worthwhile investment.
Meanwhile, Firetrail Investments sees potential in small-cap resource stocks despite their poor performance over the past 12 months. With commodity prices starting to recover, she is “seeing really interesting opportunities” in the space.
ASX small cap stocks with potential
My colleague James recently described two ASX small caps currently in favor with brokers.
Analysts at Bell Potter are bullish on the copper mine Aeris Resources Ltd (ASX: AIS). They have a buy rating and price target of 30 cents a share.
The broker highlights AIS’s strong copper mining exposure and its growth prospects, which are driven by new high-grade ore resources at the Tritton copper mine.
While Morgans analysts see significant growth potential in the regenerative medicine company AVITA Medical Inc (ASX: AVH).
The firm rates AVITA a buy with a price target of $5.60. It has withdrawn from the company’s guidance of 64% revenue growth in FY24.
Foolish relationship
Some funds believe ASX small-cap shares could be poised for a comeback. As global economic conditions change, this may or may not be the case.
Small caps may have greater volatility and may experience fluctuations more sensitive to general market movements.
As such, you should always do your due diligence before making any investment decisions.