Can Small-Cap Tech Stocks Outperform Megacaps This Year?

Many analysts believe that smaller and riskier technology stocks can outperform megacap technology stocks this year.  In 2023, investors poured money into the top seven megacap technology stocks, or the “Magnificent Seven,” which includes Apple, Alphabet, Amazon.com, Meta Platforms, Microsoft, Nvidia, and Tesla.  However, the smaller technology stocks are seen as more attractive this year with easing bond yields and lower valuations.

Bloomberg’s Magnificent 7 Price Return Index more than doubled last year, contributing to a +54% gain for the Nasdaq 100 Stock Index ($IUXX) (QQQ).  Main Street Research said, “If you didn’t own the top seven stocks last year, you weren’t able to participate in most of the returns.”  However, there are signs that this trade is reversing.  Both small and mid-cap technology sector stocks have kept pace with the megacaps since the end of October.  Also, Bloomberg data shows the average price target by analysts is for a +14.4% gain this year for small-cap tech, while it’s less than +7% for the overall Nasdaq 100.

In a positive development for small-cap technology stocks, almost 80% of the stocks within the Nasdaq 100 are above their 50-day moving averages, compared with only 13% in October. Also, more than 80% of the stocks in the Nasdaq 100 are above their 200-day moving averages, more than double those in October.  The sharp decline in bond yields has boosted most technology stocks, as the 10-year T-note yield has fallen more than -100 bp to below 4.00% from 5.00% in October. Higher interest rates raise the cost of financing, hurt the present value of earnings expected for the future, and tend to weigh on smaller and higher valuation stocks.

The outlook for a soft landing and lower interest rates is supportive for small and medium-cap technology stocks.  Federated Hermes said, “Such stocks are more dependent on the economic cycle than the Magnificent Seven technology stocks, so a soft landing is more beneficial to them overall, especially as they play catch-up after last year.  Also, artificial intelligence (AI) was a key driver for the seven, but as more companies are able to enter into and benefit from that space, it should help the rally broaden out.”

Cheaper valuations for the smaller technology stocks versus the megacap tech stocks are another factor supporting the outlook for the smaller stocks to outperform the megacaps this year.  The index of small-cap tech stocks trades at 16.6 estimated earnings, a discount to its average over the past ten years.  The Magnificent 7 Index, however, trades at a multiple of 28 estimated earnings, much more expensive than the small caps.  Main Street Research said, “Tech should continue to be in a very vibrant bull market in 2024, but it is one that will broaden out across the sector and not just be confined to the top names.”

On the date of publication, Rich Asplund did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.