- The market's largest stocks are falling back to the pack after driving gains for 18 months.
- However, leading strategists at BMO Capital Markets say US stocks can build on their gains anyway.
- Here are 15 small-cap stocks that are well positioned for a market reversal.
A long-expected shift is sending shockwaves through the stock market, but top minds at BMO Capital Markets say investors with diversified portfolios have nothing to worry about.
The mega-cap growth stocks that have fueled the S&P 500's robust, year-and-a-half-long rally finally appear to be showing substantial signs of weakness.
After a 24.2% surge, the technology-heavy Nasdaq Composite index has shed 4.3% from its mid-July peak. In the same span, the S&P 500 is down 1.4%. Meanwhile, the small-cap-focused Russell 2000 is up 8.2% since July 10 — its best stretch in that short of a timeframe since 2020.
"These longer-standing performance trends have appeared to slowly reverse in favor of smaller stocks," wrote Brian Belski, the chief investment strategist at BMO, in a mid-July note.
Strategists are keyed in on this apparent rotation since the five biggest stocks in the S&P 500 have accounted for about half of the index's gain, both in 2023 and through June of this year. If those mega-cap companies continue to give up their gains after besting the S&P 500 by 20% in the first half of the year, many fear that a pullback will ensue.
"Some investors [are] worried that market momentum cannot persist without these stocks continuing to lead the way with historically impressive performance," Belski wrote.
However, Belski and BMO's US equity strategy head, Nicholas Roccanova, cited historical data in their note, suggesting that those concerns are significantly overstated.
"Although we agree it was inevitable for these outperformance trends to start to subside, we disagree with the notion that the market cannot perform reasonably well without such a significant contribution from these stocks," Belski wrote.
Even a top-heavy market can survive a mega-cap correction
Markets are rarely as reliant on large-cap leadership as they have been this year. BMO found that outperformance by the five largest firms — Apple, Microsoft, Nvidia, Alphabet, and Amazon — versus the S&P 500 was in the 97th percentile in a six-month span going back to 1990.
But contrary to what many may expect, top-heavy markets don't tumble when mega caps peak.
In fact, the S&P 500 is usually up 11% a year after relative performance for the five top stocks tops out. Surprisingly, mega caps themselves are also in positive territory 12 months after taking a breather, albeit barely. The only exception was the early 2000s tech bubble, which Belski wrote bears little resemblance to today's market, despite what some bears have argued.
"We believe investors may be overestimating the 'risks' involved since our work shows that the stock market has held up just fine in prior periods when the outperformance of mega-cap stocks started to wane," Belski wrote.
Although companies like Nvidia and Microsoft have carried the S&P 500 higher, BMO's research shows that the market actually performs slightly better when the biggest stocks lag. The returns are close, and the chance of rising is almost identical, but it's still worth noting.
15 top small caps to buy now
If investors continue to shift away from large caps, smaller stocks that have trailed in recent years may enjoy a revival. BMO is especially bullish on small- and mid-cap companies.
Below are the 15 stocks on BMO's latest US small-cap fundamental list, which has significantly outperformed the Russell 2000 index since the start of 2008. Along with each company is its ticker, market capitalization, price-to-earnings (P/E) ratio, and sector.
