A Wall Street chief strategist says consider buying dirt-cheap 'mighty microcap' stocks, which have done even better than their large-cap peers since the coronavirus crash

• Microcap stocks are performing just as well as some investors' favorite picks but at far cheaper valuations, James Paulsen, chief investment strategist at The Leuthold Group, highlighted in a note.
• The "mighty microcaps" have outperformed their tech-sector peers and even the S&P 500's Growth Index, despite growth names usually gaining the most after a bearish tumble.
• The smallest-of-the-small stocks also trade at record-low valuations relative to the S&P 500, Paulsen noted.
• If microcaps continue to keep up with larger peers, "investors should consider diversifying some of their S&P 500 allocation," the strategist said.
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One unexpected group of stocks is performing nearly as well as extremely crowded tech giants, and investors can still get in at cheap levels, according to one top strategist.

Investors have largely neglected microcap stocks — the smallest of the small public companies — since indexes bottomed in March. That trend isn't anything new. After such a steep crash, investors typically pile into large growth names and bet on their healthy cash flow to boost their odds of outlasting an economic downturn.

Yet the market's smallest stocks are performing nearly as well as the S&P 500 and bucking the historic trend, James Paulsen, chief investment strategist at The Leuthold Group, said in a note to clients. The "mightly microcaps" significantly outperformed the Russell 2000 Small Cap Index from the market's February 19 peak to August 11, the strategist found. The subset only underperformed the S&P 500 by 2%.

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Yet microcap growth stocks beat their larger peers at their own game, Paulsen said. The Russell Microcap Growth Index leaped 7.2% over the same period, besting the S&P 500 Growth Index's 6.7% gain. Small-cap growth stocks registered a 0.8% loss.

On the other end of the stock market spectrum, value microcaps performed in-line with the S&P 500 Value Index. Both gauges beat the Russell 2000 Small Cap Value Index.

Investors' interest in tech stocks boosted microcaps even more than it did the more popular names. The Russell Microcap Technology Index gained 11.1% through the market rally, beating the S&P 500 Tech Index's 8.6% climb.

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"Much of the attention this year has focused on AAPL, GOOG, NFLX, FB, and TSLA. But, have you heard of OSTK, SRNE, APPS, or MAXR?" Paulsen said. "If the Micros can truly keep up with the Bigs, investors should consider diversifying some of their S&P 500 allocation."

Paulsen argues it's not too late yet to do so. At the end of 2018, microcaps' valuation relative to the S&P 500 was roughly the same as small caps' relative valuation at around 0.75.

Yet the two have strayed from each other throughout the pandemic. While small caps' valuation against the S&P 500 sits just above 0.5, microcaps' valuation tanked this year to a record-low 0.3. That level implies historic cheapness in the soaring stocks and sets them up for bigger gains should investors discover their worth.

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Should microcap stocks continue to rise at the same rate as the market's most-favored growth names, "they will eventually be discovered," Paulsen said.

"Who knows, maybe these Mighty Macros will someday get an acronym?" he added.

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