(Bloomberg) -- In emerging markets, large cap stocks are so 2020. A gauge of EM small caps rallied to a five-year relative high this week, bucking the lagging trend of developed peers.
The MSCI Emerging Markets Small Cap Index is up 18% so far this year, outperforming the broader gauge by 17 percentage points, as investors bet on stocks most exposed to a post-pandemic recovery. In developed markets, small cap shares are little changed against the broader market this year and have underperformed since March.
Cheap valuations and a bias toward economically-sensitive sectors are why investors in developing country markets are choosing to bet on small, according to Manishi Raychaudhuri, BNP Paribas SA's head of APAC equity research.
“Cyclicals -– particularly commodities -- have largely led earnings estimate upgrades since early 2021,” Raychaudhuri said. “In early 2021, the EM small cap index was significantly cheaper than the MSCI Emerging Markets Index, and it still remains cheaper.”
Still, the outperformance of EM smallcaps is expected to slow down in the medium term, said Raychaudhuri.
“During the initial phases of Federal Reserve's monetary policy normalization, EM stocks usually underperform and the high beta smallcap stocks could underperform more than the frontline large caps,” he said.
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