We See Big Opportunities for Small Caps in 2023—Hear the Replay from Senior Portfolio Manager Brandon Nelson’s Webcast

On a February 23 webcast, Senior Portfolio Manager Brandon Nelson drew upon his 25 years of experience in the small-cap space to share why he believes the time is ripe for a rebound in small caps, and notably the Calamos Timpani Small Cap Growth Fund (CTSIX).

An Especially Upbeat Outlook for Small Cap Stocks

Nelson recalled, “I’ve seen a lot of cycles, and they’re all a little different.” He explained that the common thread with all cycles is that small caps tend to be more volatile with bigger swings up and down that larger caps. However, he noted that this recent period has been frustrating given how long small caps have had to take it on the chin. The Russell 2000 underperformed the Russell 1000 for the sixth year in a row, which Nelson found shocking because small caps tended to win when we look back over 100 years. The good news, according to Nelson, is that things look to be finally turning around for small caps.

Nelson’s key points:

• Small cap valuations have de-risked almost any way you look at them. They’re trading at a substantial discount to the S&P 500 and the Russell 1000. So we’ve got attractive valuations on the side of small caps.
• Disinflation is also on the side of small caps. When inflation comes down, it has historically provided a tailwind for small caps both in absolute and relative terms.
• The year 2022 was the third-worst year for the Russell 2000 Growth Index since its creation in the 1970s. But, for Nelson, the obvious question is: “What was the next year like?” On average, the Russell 2000 Growth Index was up 21% and the median stock in the index was up close to 25%.
• For the last 15 months, macro factors have dominated stock price movements. It started with Thanksgiving 2021 when the Fed became more hawkish. With the calming of macro conditions and less attention toward them, there should be an acceleration in the appreciation of small caps.
• We went through a period of multiple severe contractions in valuations, which settled down last summer even though the Fed continued to raise interest rates meaningfully.

When the Pendulum Swings To Small Caps with Fundamental Momentum, Nelson Believes CTSIX Will Be There in a Big Way

Nelson expressed a strong conviction that the pendulum is swinging in favor of CTSIX’s strategy and portfolio.

• In terms of picking stocks from a bottom-up standpoint, he sees tremendous opportunities as the team seeks out fundamental momentum based on robust and sustainable growth, and underestimated growth where companies have a knack for beating expectations and raising guidance.
• Nelson noted that the team has been consistently better at finding upside surprise relative to the upside in the Russell 2000 Growth Index benchmark. Approximately 76% of CTSIX stocks show an upside sales surprise (relative to consensus) compared with 59% for the benchmark.*
• In late 2022 and early 2023, many of the prior losers rallied sharply because of some benign macro data points. Inflation came in cooler than expected, triggering the buying of beaten-down stocks that had lousy fundamental profiles. Nelson noted, “We didn’t fully participate in that uptick because we own higher-quality, higher-growth names with better price momentum. We think January marked the capitulation of that mood.”
• He also noted that the best thing to do right now is to keep the portfolio positioned in names that have those fundamental momentum characteristics and wait for the pendulum to swing the team’s way. “When it does, we believe we’ll be there in a big way.”

To learn more about how CTSIX’s active strategy strives to capitalize on small-cap companies offering secular growth with visible revenue streams, listen to the full replay and Q&A with Brandon Nelson, CFA, here. He also shared examples of his security selection process in action.