ASX small-cap shares might be experiencing a resurgence if recent market trends hold.
The S&P/ASX Small Ordinaries Index (ASX: XSO) – a proxy for Australian small caps – is up nearly 1.3% in the past week.
Meanwhile, the large-cap S&P/ASX 200 Index (ASX: XJO) is up around 0.7%.
But the picture is reversed when looking back at the past 12 months. In that time, the ASX 200 is up nearly 9%, whereas the small-cap index is up just 5%.
As a reminder, small-cap shares are typically those companies with a market capitalisation below $2 billion but above the $100–200 million mark.
According to StockTwits on X, there was a "huge rotation out of tech and into small caps" in the US session on Thursday.
That strength has continued on the ASX today, with the small-cap index up more than 1.1%. The ASX 200 has yet to break the 1% barrier.
Is the tide beginning to turn for ASX small-cap shares? Let's take a look.
ASX small-cap shares to rise?
Global share markets were on edge on Thursday after the US released June consumer price index (CPI) data.
Core CPI for June came in at 3.3% year over year, below the market's expectations of 3.4%.
Speaking to US Congress on Wednesday, Federal Reserve Chair Jerome Powell said the US was "no longer an overheated economy".
This is en economy…that is more of less back by most measures to where it was before the pandemic.
We're well aware that we now face two-sided risks and have for some time.
The unexpected decline triggered movements in large-cap stocks. Major tech stocks experienced notable declines, even though many had recently hit record highs, so a pullback had been anticipated.
Nevertheless, the data has some speculation that the Federal Reserve might cut interest rates as early as September.
Small-cap shares are "more vulnerable to recent interest rate rises", according to JP Morgan Asset Management, so this helps explain the recent movements.
According to Charles-Henry Monchau, Syz Group's CIO, the odds of a rate cut by September 2024 have skyrocketed to 83%.
Meanwhile, The Australian Financial Review reported the probability of a rate cut could be as high as 90%.
Before the June CPI report, the odds were 67%.
Scotiabank said the likelihood of a rate cut is now higher. Analyst Derek Holt commented, per The AFR:
Another softer core CPI reading makes our forecast for 50 basis point cuts this year starting in September look a little light.
The money that rolled into smaller equities on Thursday continues a trend that has been in place on the ASX since the start of the new financial year.
Since July began, the small-cap shares index is up 2.2%, compared to the ASX 200's 2.2% return at the time of writing.
What ASX small-caps performed in FY24?
Two small-cap shares have caught serious investor attention of late, resulting in large gains in their stock prices.
The first is Droneshield (ASX: DRO). The counter-drone technology company saw its shares soar by over 647% in FY24, as seen below.
Investors are bullish on the company after several updates. For one, it secured a number of repeat orders of its counter-drone technology from the US Military. Secondly, its financial results saw revenues grow 900% year over year in Q1 CY 2024 to $16.4 million.
Tamim Asset Management is bullish on the company, noting it is "well-positioned to capitalise on the increasing need for effective counter-drone technologies".
Another small-cap player currently outperforming is Zip Co Ltd (ASX: ZIP). The buy now, pay later (BNPL) company experienced a 256% increase in its share price during FY24.
Zip is now focused on key markets to drive revenue growth after a challenging period due to the pandemic.
The stock is rated a buy from Ord Minnett, and the consensus verdict is also a buy from analysts, according to CommSec.
Takeouts
ASX small-cap shares may be back in vogue, driven by a broader market shift and some impressive company performances.
Just remember that small-cap stocks may be more volatile and that you should always conduct your own thorough due diligence.
