By Lewis Krauskopf

NEW YORK, (Reuters) – Some investors think the stars are aligning in favor of small-cap stocks. The category is expected to reap the benefits of low valuations and robust economic growth, along with a benign effect from looming tax policies.

The largest monthly inflow into small-cap equity funds since March has been $2.4 billion, data provider EPFR reports. That’s helped fuel a 6% gain in the S&P 600 small-cap index since late October, nearly doubling the large-cap S&P 500’s performance in that period. About 5% is seen in the broader index of small-caps.

As investors thought that small cap stocks would reap the benefits of a wide-ranging U.S. economic recovery, they rallied in 2021’s early months. They floundered in subsequent months, when technology stocks took the market’s reins amid worries over whether the Delta variant of the coronavirus would stifle the economic rebound. The Russell 2000 rose 19% in this year’s comparison to a 25 percent rise for the.

With a blistering S&P 500 rally stretching valuations on large-cap stocks and above-trend U.S. growth expected next year, some investors now believe small caps are a bargain.

According to BofA Global Research, the forward price to earnings ratio for the Russell 2000 was 24% lower than the Russell 1000. Small caps trade at historic discounts on historical measures like price-to book and price-tosales.

“Smaller-cap stocks on a relative basis just look much more attractive,” said Ryan Jacob, chief investment officer of Jacob Asset Management.

His firm’s growth stock funds “probably have our highest weightings ever” in small-cap shares compared to large, Jacob said.

RBC strategists said the U.S. economy is expected to expand 4% next year, compared with its long-term average of 2.5%, and believe small caps are a “pure play” on domestic growth. Analysts at BofA Global Research said the disparity in valuations between larger companies and smaller ones suggests high single-digit price returns annually for the Russell 2000 over the next decade compared with slightly negative annual returns for the S&P 500.

Chuck Carlson is the chief executive officer of Horizon Investment Services, Hammond, Indiana. He said that his company has increased small-cap exposure over the last four months. This includes shares in a shipping company. Matson (NYSE) and the semiconductor company Onto Innovation, (NYSE).

Carlson explained, “After trading fairly sideways for seven month’s, you had a very nice breakout.” “We love the fundamentals.”

The improving picture for smaller companies comes as a relief to investors looking for ways to diversify out of the megacap technology stocks that have led markets higher for most of the last decade, with the top five companies alone comprising more than 23% weight in the S&P 500.

“Now you don’t have to be in a FAANG stock to get some reasonable growth,” said Mike Petro, portfolio manager of the Putnam Small Cap Value Fund, using a common acronym for massive tech and growth stocks such as Apple (NASDAQ:) and Amazon (NASDAQ:). It is possible to invest in small-cap stocks that are not well known and still get nominal growth. Jacob Asset Management’s Jacob Jacob has reduced his holdings in the megacap stocks Alphabet and Facebook (NASDAQ) parents Meta Platforms while favoring smaller businesses like OptimizeRx and Digital Turbine.

Some investors remain wary of small caps, which over the past decade have lagged overall, with the Russell 2000 rising 230% against a 285% gain for the S&P 500.

The possibility that COVID-19 has swept the United States like it did in other European countries could cause investors to shift away from sensitive stocks into tech companies. These technology companies are likely to be more resilient to short-term fluctuations in growth.

The Strategists Wells Fargo (NYSE:) Investment Institute this week urged investors to take profits on gains in “lower-quality” small-cap stocks and move into larger-capitalization companies, saying the economy is entering the middle phase of its expansion where growth historically has slowed.

However, others believe that they can be an escape hatch if the tax policy changes supported by Biden’s administration, including a minimum 15% tax for companies earning more than $1 billion, are made into law.

According to analysts from Ned Davis Research who recently began favoring small caps, this could lead to a decrease in the impact of small-cap stocks.