Small caps could be jolted to life with rate cuts, but what’s Plan B if they don’t come?

Rate cuts could boost small caps as banks with valuations pumped to the gills take a hit, but this fundie says we need a Plan B.

What's your Plan B if rate cuts don’t come? Pic: Getty Images

• Rate cuts set to boost small caps, says fundie

• Banks may lose out to undervalued, smaller-capped stocks

• Plan B? Diversification, Oscar Oberg says

Oscar Oberg, a portfolio manager at Wilson Asset Management, recently sat down with CommSec to chat about the current Aussie market.

Here’s what he had to say…

Rate cuts will be great for small caps

Oberg said the market’s been waiting for a rate cut from the RBA for years, and he reckons when it happens, it will jolt the markets.

"Small and mid-cap companies have underperformed large caps for the last three and a half years," Oberg explained.

He reckons  that with a rate cut, small caps might finally get their time in the sun. 

He pointed to the US and New Zealand, where rate cuts have sparked small-cap outperformance. He believes it’s just what the Aussie market needs.

Oberg is particularly excited about the potential in sectors like retail, automotive and media, where a lot of small companies are "trading at very, very low valuations." 

Once the rate cut happens, he thinks these stocks could get a boost.

The shift from banks to small caps

Oberg also sees a possible shift of capital out of expensive sectors like banks and into the undervalued small-cap stocks. 

"The banks have done well, but there’s a lack of earnings growth, and they’re expensive," Oberg said. 

He noted that Commonwealth Bank (ASX:CBA), for example, is trading at an all-time high valuation – about 28 times earnings. 

Compare that to a smaller capped companies, some of which trade at just 10-12 times earnings, and you see the big potential for a shift in capital.

Oberg’s confident the rate cut will trigger this move. 

"That re-rate will happen once investors are confident rates won’t rise anymore, and cuts are on the horizon," he said.

The importance of Outlook Statements

For Oberg, the key thing to watch will be the outlook statements from companies in their updates. 

He mentioned New Zealand as an interesting case.

Despite weak earnings reports, companies in NZ saw stock prices rise, a phenomenon that he thinks could play out in Australia as well. 

"If companies like Harvey Norman Holdings (ASX:HVN) mention that things are picking up in New Zealand, the market will take that as a signal that Australia might follow suit," he explained.

He’s also particularly keen on how sectors like media are doing. 

"Outdoor media spend in New Zealand is up 40-50%," he said. If that trend holds, expect a positive response from the Aussie market.

AI and tech trends

Oberg also sees AI as a growing force, even if it hasn’t fully hit Aussie shores. 

He’s keeping an eye on companies like Gentrack Group (ASX:GTK), Catapult Group (ASX:CAT), and Ai-Media Technologies (ASX:AIM), which are well-positioned to benefit from AI advancements.

 "These companies have been great performers for us," he said, pointing out that many small caps go through a period of loss-making but eventually turn into solid investments once they hit profitability.

He also gave the example of Temple & Webster (ASX:TPW), which used AI to improve its customer service. 

"They shifted a lot of their help desk inquiries to AI and actually got better results," he said, highlighting how cost savings can be reinvested to boost sales.

What’s the big risk and what's Plan B?

If there’s one thing Oberg’s wary of, it’s the risk that expensive stocks won’t meet expectations.

 "The high-valuation companies have been sold off when they miss expectations..." he noted. 

But, with rate cuts potentially changing the game, Oberg thinks there could be more upside for undervalued small-cap stocks, especially if interest rates stay low.

And what if the rate cut doesn’t come?

Oberg said diversification is key.

He pointed to his own portfolio at Wilson, which is diversified; so even if the rate cut doesn’t materialise in February, the fund has got a backup plan.

 "We stay pretty liquid and flexible with cash levels," he said. 

However, he’s still bullish on small caps, which have underperformed by over 20% in the last three and a half years. 

"Even if the outlook doesn’t improve, if it stabilises, that’ll allow a re-rate for some of these stocks."

The next RBA Board meeting and Official Cash Rate announcement will be on the 18th February 2025.

The views, information, or opinions expressed in this article are solely those of the portfolio manager and do not represent the views of Stockhead.

Stockhead has not provided, endorsed or otherwise assumed responsibility for any financial product advice contained in this article. 

Originally published as Small caps could be jolted to life with rate cuts, but what’s Plan B if they don’t come?