Viewpoints
2020 Outlook: US Small Cap

Timely insights from portfolio managers and industry experts on key financial, economic and political issues.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.

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      By Mike McLean, CFA Co-Director of US Small Cap Equity, Eaton Vance Management

      Boston - We think identifying high quality businesses that can grow their earnings at attractive returns on capital could be a great source of alpha1 in 2020.

      EVX_49873_Thumbnail_McLean_1_680px

      From multiple expansion to earnings growth

      The early read on 2020 earnings expectations has been negative for the most part. Stocks have still done well in the small cap universe, driven predominantly by multiple expansion. Successful small cap investing in 2020 will likely be about identifying earnings growth.

      We take a sector-neutral approach. Regardless of the economic and policy backdrop, we believe that there are always opportunities across sectors to identify those quality businesses that may be able to compound returns over time, thanks to their attractive competitive positioning.

      With a full-employment backdrop, we need to focus on businesses that can grow, driven by idiosyncratic, company-specific fundamentals that can carry them through a variety of economic backdrops moving forward.

      Pressures on profit margins

      The biggest risk in small cap in 2020 is continued profit margin pressures.

      Within the US small cap universe, operating margins peaked for this business cycle in 2017. Roughly one-third of the benchmark2 was unprofitable at the end of 2019. And balance-sheet leverage is at or near cycle highs.

      We think we'll see continued margin pressures for the universe more broadly, predominantly driven by a tight labor market, which is characteristic of a late-cycle environment.

      Identifying businesses that can grow their top lines, expanding margins and returns on capital to combat those late-cycle pressures, helps to provide great opportunities for us to take a long-term mindset.

      Bottom line: Given this backdrop of a lower quality benchmark, we think being higher quality — and taking an active approach within small caps — will be necessary to identify alpha opportunities.