Spotlight on Mid-Cap Stocks as a Smart Play in Market Downturns and Recoveries.

As investors, the search for the next big opportunities and emerging themes is constant. Looking ahead to 2025 and beyond, several key trends are worth watching.

Emerging Opportunities: AI, Lower Inflation, and Interest Rates

AI's Rise: 2023 marked a significant year for AI, especially with the explosion of generative AI applications like ChatGPT. Companies like Nvidia, whose stock has soared by over 161% by mid-2024, have benefitted from the growing demand for high-performance chips. According to the 2024 Comptia IT Industry Outlook Report, nearly 22% of firms are actively integrating AI into workflows, this trend is set to accelerate into 2024. In sectors from healthcare to logistics, AI will continue to transform industries, and mid-cap companies involved in AI infrastructure could see outsized growth as the sector matures.

Lower Inflation and Interest Rates: Inflation has been a hot topic globally, but signs point to a cooling trend. In New Zealand, inflation has dropped to 3.3%, down from a high of 7.3% in 2022. This has led to expectations of lower interest rates, creating a more favourable environment for businesses to grow.

When central banks implement easing policies, mid-cap companies typically gain more from increased access to capital for expansion compared to their larger counterparts. This is often due to mid-caps relying more on flexible-rate loans, which respond quickly to lower interest rates, reducing borrowing costs. In contrast, large-cap companies, with more fixed-rate debt, may not experience the same immediate benefit, but still stand to gain when issuing new debt at lower rates. This makes mid-caps more agile in capitalising on favourable financial conditions, giving them an edge in pursuing growth initiatives.

Mid-Cap Stocks: Why They Stand Out

The mid-cap sector has consistently outperformed both large-caps and small-caps during periods of global uncertainty, including the coronavirus pandemic and over the long term. For example, over 25 years preceding August 2024, the S&P Mid Cap 400 delivered a total return of 985%, sharply outpacing the S&P 500’s 563% and the Russell 2000’s 608%  (Mid-Caps Used To Outperform Large-Caps. What Changed?, 2024). This trend, marked by strong performance through economic downturns and global challenges, is expected to continue over the long term.

One of the primary reasons for this outperformance is that many mid-cap companies are still in their growth phase, unlike large-caps, which tend to be more stable but slower-growing. Ross MacMillan, senior analyst at Morningstar Australasia, explains that mid-caps often offer higher revenue and earnings growth potential, leading to more significant share price movements. These companies, while more established than small caps, retain the growth potential and competitive advantages that attract investor interest.

During the pandemic, mid-cap technology companies like Afterpay (ASX: APT), Xero (ASX: XRO), and NextDC (ASX: NXT) thrived. For instance, Afterpay benefited significantly from the rise in online shopping, driven by its "buy now, pay later" business model. The company's revenue skyrocketed during the pandemic, with its share price climbing from $8 to $70. This substantial growth solidified Afterpay as one of Australia’s top companies by market capitalisation before its acquisition by Square (now Block Inc.) in 2021.

The mid-cap sector also offers greater diversification benefits, as these companies are often more agile and adaptable to market shifts, making them attractive during periods of economic uncertainty, including wars, pandemics, and other global crises.

Why Mid-Cap Stocks Could Be Your Smart Play:

Less Impact from Foreign Institutional Investors: Large-cap stocks tend to be heavily influenced by foreign institutional investors, who frequently rebalance their portfolios, often leading to volatility. Mid-cap stocks, however, experience less of this external pressure, making them more stable during periods of market rebalancing.

High Risk-Reward Potential: While mid-cap stocks present higher risk and reward compared to large caps, which are generally more stable but slower growing, the key to reducing risk lies in diversification. A balanced portfolio that includes both mid-cap and large-cap stocks benefits from the lower correlation between these segments. This diversification reduces overall volatility and risk. As the saying goes, “The sum is greater than its parts,” which holds true for optimal portfolios—by mixing assets with varying risk and return profiles, investors can achieve better risk-adjusted returns.

Agility and Adaptability: Mid-caps can be nimbler, allowing them to pivot quickly in changing markets. Generally, Mid-cap companies often possess the flexibility and agility to pivot quickly in response to market changes, which sets them apart from larger, more bureaucratic organisations. This adaptability allows them to innovate, restructure, or seize emerging opportunities faster than their larger counterparts.

Lower OCR Benefits: In a low Official Cash Rate (OCR) environment, mid-caps have an advantage in accessing cheaper capital. Companies like Heartland Group (HGH.NZ) are well-positioned to expand with lower borrowing costs, which could drive growth over the next few years.

Undervalued and Acquisition Opportunities: Many mid-caps are undervalued and underappreciated by large institutional investors, despite having strong fundamentals. This often makes them prime acquisition targets for larger companies, which can drive up their stock price and market sentiment. For instance, Manawa Energy (MNW.NZ), poised for growth in the renewable energy sector, has recently become the subject of an acquisition by Contact Energy in a deal valued at NZ$1.86 billion. This highlights how undervalued mid-caps can attract big players, potentially leading to significant gains for investors.

Mid-Cap Stocks/funds to Watch

Ophir High Conviction Fund (OPH.ASX): The Fund seeks to provide investors with a concentrated exposure to a high-quality portfolio of Australian listed companies outside the S&P/ASX 50. On occasion, the Fund may also invest in listed securities in New Zealand. OPH has shown impressive returns by carefully selecting mid-cap companies with promising fundamentals. With a focus on quality management and scalability, OPH invests across sectors such as healthcare, technology, and financial services, capitalising on growth opportunities in these areas. Net return since inception is 13.2% p.a. The YTD return for OPH is 20.88%.

Vanguard Mid-Cap ETF (VO.US): The Vanguard Mid-Cap ETF is a popular fund in the U.S. that offers exposure to mid-cap companies across various industries. VO is designed to track the performance of the CRSP US Mid Cap Index, providing diversified access to companies with market capitalisations typically ranging from $2 billion to $10 billion. The ETF holds companies that are established but still have significant room for growth, such as those in technology, healthcare, and consumer sectors. Net return since inception is 9.91%. The YTD return for VO is 17.53%.

New Zealand Mid-Cap Stocks:



Wrap Up: The Strategic Case for Mid-Caps

In today’s market, mid-cap stocks offer a compelling balance of risk and reward, especially as we anticipate lower interest rates and capital markets begin to favour more agile businesses. With many mid-cap companies showing strong performance across New Zealand, Australia, and the US, now may be the time to add them to your portfolio. These stocks present unique opportunities for growth and are well-positioned to navigate both downturns and recoveries.

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