Cautious gallop for small caps

WHILE the Fire Horse appears to be sauntering out of its stables in relation to the FBM KLCI since Feb 17, it must be acknowledged that 2026 has started with a bang for the premier index with an average year-to-date (y-t-d) return of 4.5% .

The same, however, cannot be said of the FBM Small Cap Index, which in comparison to its big-sister bourse, has posted a moderate 1.4% return since Jan 1.

Analysts and fund managers, while generally optimistic about the FBM Small Cap Index improving as the year progresses, particularly in the second half (2H26), present varied scenarios indicating it may not be a broad-based bull run for the index, making stock or industry selection crucial.

Small-cap counters, loosely defined as those with a market capitalisation of between RM500mil and RM1bil, are widely known to carry higher beta, or sensitivity to overall market conditions.

However, RHB Research, in its May “20 Jewels” report, noted that “a renewed focus on digital transformation, technological advancements, accommodative government policies, sustainability and regional integration will continue to provide fertile ground for small-cap companies”.

“This fresh momentum underscores the growing importance of the smaller but more agile players, positioning them as potential key beneficiaries in a rapidly evolving economic landscape.”

Assistant manager of research at iFast Capital Kevin Khaw observes that the relative lag of the FBM Small Cap Index is primarily because the market recovery since mid-December 2025 concentrated on large-cap, blue-chip counters such as banks, property stocks and real estate investment trusts or REITs.

He says this concentration has occurred because these larger sectors were the first to benefit from an improving corporate earnings outlook and a strengthening ringgit.

“Additionally, small and mid-cap counters suffered from pessimistic analyst downgrades throughout 2025 due to external risks like global trade tensions, chip curbs and tariffs.

“The recent uptrend has also been driven by strong foreign inflows, which typically target large-cap stocks first, especially given Malaysia’s high weighting in the MSCI Asean Index,” he tells StarBiz 7.

However, echoing the optimistic sentiment of the RHB Research team, Khaw says upcoming corporate results for the first quarter of the year (1Q26), typically due in May, are expected to be a major turning point as the current strong momentum in large-cap stocks is likely to broaden to mid and small-cap counters.

Of note, he says analysts have already begun upgrading earnings forecasts for the small-cap segment, believing the previous year’s downgrades were overly pessimistic.

“Financial projections for 2026 indicate a massive recovery for the FBM Small Cap Index, with projected earnings growth of 64.97% to 65.49% (as of Feb 12), representing a significant reversal from the 8.2% contraction experienced in 2025.

“As these improved earnings materialise in quarterly reports, they should act as a catalyst for the small-cap index to close the performance gap,” he projects.

Moreover, he points out that the overall outlook for the FBM Small Cap Index for the rest of 2026 is highly positive, with the segment positioned to potentially generate greater alpha driven by these strong upward earnings revisions.

Alpha in this sense refers to the excess return an investment can generate beyond what is expected.

Khaw says the broader economic environment remains supportive, characterised by resilient domestic gross domestic product or GDP growth that has consistently exceeded market estimates and a stable overnight policy rate.

“Small-cap companies are also set to benefit from supportive government policies under the 13th Malaysia Plan, which focuses on ‘high growth, high value’ sectors, alongside specific financing aids for small-medium enterprises and green energy initiatives.

“Furthermore, robust domestic consumption, boosted by cash aids and a healthy labour market, provide a solid foundation for the domestic-oriented companies that often populate the small-cap index,” he says.

On the flip side, Khaw is anticipating some global trade turbulence in light of the latest Stateside tariff development, as the analyst is unsure how US President Donald Trump will execute his tariff strategy.

“Nevertheless, the outlook for small-cap players remains bright, and we are predicting the divergence between large-cap and small-cap players will begin to narrow in a positive way this year once the macro headwinds are resolved,” he says.

Head of equity sales at Rakuten Trade Vincent Lau notes that it is typical for large-cap counters to benefit from fund inflows first before the small caps start to benefit from the spillover.

Despite the belief that 2H26 should turn out better for the FBM Small Cap Index, he says funds are still largely parked in banking counters and other blue chips.

“Small caps are also usually more attractive to retail investors, and these investors need to be convinced to adopt a more risk-on approach, while at this moment many are still neutral.

“Institutional investors, meanwhile, have to start looking elsewhere for value beyond blue chips,” Lau says.

Nonetheless, he says with South Korea’s Kospi and Taiwan’s Taiex riding on the crest of the technology boom, buoyed by record-high share prices of counters such as Taiwan Semiconductor Manufacturing Co Ltd and SK Hynix Inc, Lau believes the tech optimism could induce a second spillover effect on Bursa Malaysia.

“It is likely that investors are looking for value among small caps at the moment, so sectors that are seen to perform well could see a rebound,” says Lau.

Offering a more neutral perspective, chief investment officer at Tradeview Capital Nixon Wong explains that the y-t-d foreign inflows into Bursa Malaysia, measuring approximately RM1.4bil, are a result of fund outflows from developed markets like the United States amid the weakening of the dollar.

“When foreign investors move into markets like Malaysia, they will typically select more liquid stocks, which are the large caps. Small caps typically have lower liquidity, making them less attractive to big funds.

“Also, to manage market risk and volatility, small caps are often seen as higher risk, so fund flows are less likely to pay much attention to them when markets are cautious,” he says.

While recognising that earnings can shift sentiment if they surprise positively, Wong cautions that structural drivers of performance in terms of liquidity, risk premium and investor preference are bigger determining factors for consideration.

“Hence, earnings alone might not fully close the gap unless results strongly outperform expectations. Still, better economic data, pick-ups in consumer spending or increased infrastructure activity can benefit many small-cap sectors.”

Remain cautiously constructive as Wong notes that small caps face downside risks from global macro shocks, sector-specific challenges like foreign-exchange risk on exporters, or choppiness in commodity prices.

Of interest, RHB Research has picked D&O Green Technologies Bhd, TT Vision Holdings Bhd and EG Industries Bhd among some of the tech-related stocks to look out for, while also outlining healthcare counters such as Alpha IVF Group Bhd and Apex Healthcare Bhd.

At the same time, the brokerage firm has selected Ancom Nylex Bhd, Sumisaujana Group Bhd, PGF Capital Bhd and Feytech Holdings Bhd as notable manufacturing counters.