The eventual re-engineering of the Tacoma Narrows Bridge led to a stronger, more resilient structure, built with a deeper understanding of its environment. Similarly, the shift from large-cap growth to small-cap value is not a disaster but an opportunity to build a more balanced portfolio.
For years, the investment world has been dominated by large, well-known companies, particularly the "Mag 7." We believe this era of market leadership stretching over 15 years has evolved into a speculative tech bubble. While this trend has been a powerful force, experienced investors know that behavior can lead to extremes on either side of the equation. According to writer and market technician, Jared Dillian, we're on the cusp of a major shift: a market rotation that could fundamentally change the investment landscape.
A traditional way to categorize stocks is based on two key characteristics: company size (large, mid, or small) and investment style (growth or value). For decades, large growth companies have been the darlings of the market. Dillian notes that this dominance has left smaller, value-oriented stocks—the "old economy" companies—significantly undervalued. He harkens back to the dot-com bubble, when value stocks were left for dead only to lead a massive bull market in the early 2000s, outperforming growth by a huge margin.
Several factors have propelled the long-term dominance of large growth companies. Dillian points to three main theories: the unique strength of U.S. technology stocks, an increase in regulation that favors larger companies better equipped to handle compliance, and higher interest rates that disproportionately hurt smaller companies with less access to favorable financing. However, he believes these tailwinds are likely to reverse, setting the stage for small value companies to have their moment in the sun.
For investors looking to capitalize on this rotation, the path forward requires a thoughtful approach. Dillian cautions against simply buying a broad index ETF like the Russell 2000, which can contain many under performing stocks. Instead, he advocates for a more strategic approach, emphasizing the importance of stock picking within the small and value categories to uncover hidden gems. The upside, could be interesting with returns mirroring the significant gains seen by value investors after the dot-com bust.
“We’re on the cusp of a major shift:
a market rotation that could fundamentally
change the investment landscape. ”
The sentiment around small and value stocks is at a low point. This represents an indicator to value investors of potential opportunity. For those who have been reading our newsletters you will understand why we believe this; see our thoughts on gold and energy, which have come to fruition.
For those with a discerning eye, change is underway. The era of market-wide, passive gains is waning. At Pilot, we believe this market rotation is not a risk to be avoided but an opportunity to be seized. We're charting a course toward these undervalued and overlooked sectors, understanding that the most rewarding journeys are often those that take us off the beaten path, just as we have proven in the past. This isn't a hasty pursuit but a deliberate one. We began allocating to this strategy just over a year ago. We were a little early, but we have significant conviction in the risk/reward opportunity with smaller stocks.
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