These small caps could outperform during tough environment for the group, Goldman says

Published Mon, Feb 7 20229:34 AM ESTUpdated Mon, Feb 7 202212:11 PM EST

2022 is shaping up to be a difficult year for small-cap stocks, with decelerating economic growth and tighter monetary policy in sight. For investors looking for bargains in small companies, Goldman Sachs said some can still outperform in the tough environment. The Russell 2000 small-cap index started underperforming the rest of the market last year, as the boost from the pandemic rebound faded. Meanwhile, rising rates and increasing costs on things such as wages also dented the appetite for smaller companies. The benchmark has dropped 18% since early November compared with a 4% decline for the S & P 500. During the last 12 months, the small-cap index has lagged the S & P 500 by 25 percentage points, marking its worst 12-month relative return since 1999, according to Goldman. The group is faced with an uneasy macroenvironment this year as the cyclical tailwind started to wane and as the Federal Reserve is ready to embark on its tightening cycle. Small-cap stocks tend to be very sensitive to fluctuations in the economy and market sentiment because of their small size. "During the last 20 years, small-caps have lagged on average in periods when the yield curve was flattening, economic growth was strong but decelerating, or financial conditions were tightening," Goldman chief U.S. equity strategist David Kostin said in a note. However, Goldman said some small-cap names still have the potential to beat the market, and investors should look for firms with fast growth, high profit margins and moderate valuations. The Wall Street firm screened for Russell 2000 companies that meet the following criteria: over $1 billion in market cap consensus 2023 sales growth above 10% consensus net profit margins above 10% below-average sales multiples The list of stocks includes a mix of cyclical and defensive industries like software and energy. Two energy players, Northern Oil and Gas and Murphy Oil , have outperformed the S & P 500 this year with 19% and 27% year-to-date gains, respectively, and Goldman believes they could continue the strength given the solid fundamentals. Marathon Digital and Riot Blockchain are two software small-cap stocks that Goldman thinks could fare well in a difficult year. Other names include Federated Hermes , Crocs , Focus Financial and Sun Country Airlines.

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