Deutsche Bank strategists expect small-cap European stocks to significantly outperform large-cap stocks in the coming months, citing three key factors that could drive this growth. The bank maintains a positive outlook for European SMEs, despite their performance being lower than that of larger companies at the start of 2024. The stock index fund returned 7.4% over the same period. XXSC-DE EMUL^-IT YTD line The bank said three key catalysts could unlock “significant” value in the shares of these smaller companies. Lower interest rates Deutsche Bank said investors are nervous about higher-than-expected interest rates in 2024, which is one of the main reasons why small and medium-sized companies have lagged their larger peers this year. “These concerns no longer appear to be justified,” Deutsche Bank strategist Maximilian Uleer said in a note to clients on Dec. 13, noting that the difference in borrowing costs for smaller companies compared with larger companies has been at its lowest level in several years. back. This development is particularly important for smaller companies, which tend to rely more on borrowed money than larger companies. Profits improve European small businesses have improved significantly after profits fell sharply by 40% in the last quarter of 2023, according to the investment bank. Deutsche Bank said that profits of small and medium-sized enterprises will grow by 14% in the third quarter of 2024, and it is generally expected to achieve stronger growth of 25% in the fourth quarter. “We expect this to return to investors’ attention,” the bank’s strategists wrote. Manufacturing rebound While Deutsche Bank acknowledged a rebound in manufacturing confidence is the least predictable of its three key drivers, they expect European businesses to overall confidence will improve. Eurozone manufacturing grew increasingly weaker in November, according to the latest S&P Global Purchasing Managers’ Index data. The euro zone manufacturing purchasing managers’ index showed that new factory orders, production, purchasing activities and inventories all deteriorated faster. Employment fell at its sharpest pace since August 2020, especially in Germany and Austria, while output prices were “even more heavily discounted” given continued weak demand. However, the bank said a reversal in the downward trend could be particularly beneficial for smaller companies, which typically have significant exposure to manufacturing activity. Economists expect a modest recovery in global manufacturing activity next year, supported by lower global interest rates, the bank said. How much room for upside is there? Deutsche Bank strategists predict that if small-cap valuation metrics return to historical averages and assuming profits grow at the typical long-term growth rate of 12% per year, the stocks could return 18% annually over the next three years. “The upside potential from a valuation re-rating is substantial,” the strategists noted. However, the bank warned investors to be patient. Strategists also admit that they were wrong to be bullish on European small-cap stocks earlier this year because they made predictions too early. “We reiterate our positive stance on SMID, but again stress that this requires patience and does not imply short-term trade thinking,” the bank said. — CNBC’s Michael Bloom contributed reporting.
