PETALING JAYA: The tail-end of the year of the Wood Snake has been kind for the FBM KLCI as the bourse gallops into the Fire Horse period, having seen a rise of close to 5% year-to-date (y-t-d).
Given the premier index’s encouraging performance thus far, the FBM Small Caps appeared to pale in comparison, having registered a relatively lacklustre 2% increase since Jan 1 to Feb 19, with analysts believing that investors have hitherto favoured blue-chip strength, while avoiding the higher beta exposures of small caps.
Having said that however, experts are still upbeat about the prospects of the FBM Small Caps for the year, especially towards the second half of 2026, although the rebound could be tampered with persistent external risks and selective buying.
Investment strategist and country economist at IPP Global Wealth Mohd Sedek Jantan pointed to the fact that market fund flows had remained predominantly driven by foreign and domestic institutional investors.
He said this group of investors prefers quality, earnings visibility, and liquidity, as they seek relative refuge amid heightened global macroeconomic uncertainty and ongoing geopolitical tensions.
Alluding to one off-missed downside to a strong currency, he said: “The lag in small caps is due to a strengthening ringgit, which has compressed profit margins for many export-oriented small and medium enterprises (SMEs), weighing on earnings visibility and limiting valuation re-rating.
“Local retail participation also remains subdued, particularly in the small-cap segment. Investor confidence has yet to fully recover from the double-digit drawdown of around 12% recorded in 2025, which continues to discourage risk-taking in lower-liquidity names.”
A research head with a foreign brokerage firm resonated with Mohd Sedek’s view, noting that the FBM Small Cap Index’s lag behind the FBM KLCI so far in 2026 stems from a combination of lingering 2025 headwinds and early-year market dynamics that favour stability over risk.
“Small caps are inherently more volatile and sensitive to external shocks, which has kept them sidelined while large caps benefit from a risk-averse rally,” she said.
The research head added that the market has shifted toward blue chips amid foreign outflows last year and a risk-off posture, before explaining that large caps, with their lower beta and exposure to stable sectors like banking and industrials, have driven the FBM KLCI’s 4.6% y-t-d gain, while small caps remain exposed to domestic SMEs, manufacturing, and services that haven’t yet seen broad recovery.
“Over the past decade, many Malaysian stocks, especially smaller ones, have faced stagnant profits and margin erosion from competition in low-cost economies like China and Vietnam.
This has contributed to the underperformance, with small caps trading below long-term valuation means and lacking the artificial intelligence (AI)-driven boosts seen in regional peers,” she said.
Looking ahead, Mohd Sedek believes that the release of corporate results for the first quarter of this financial year (1Q26) can help stabilise sentiment but is unlikely to trigger an immediate rotation away from large caps.
He opined that the market will treat 1Q26 mainly as a validation quarter to narrow scepticism, rather than a turning point proper, before remarking that a broader re-rating is more likely to require confirmation beyond the first quarter.
“Investors will be looking for early signs that margin pressure from the stronger ringgit is easing and that earnings upgrades are beginning to materialise, but liquidity preference is likely to remain with large, defensive names through 1Q26,” said the strategist.
At the same time, the research head told StarBiz that corporate earnings could indeed catalyse a shift, but the impact might be more pronounced from 2Q26 onward.
She said 1Q26 (reporting in May) will likely reflect lingering 2025 weaknesses, but improving macro conditions and forward guidance could spark rotation into small caps.
Elaborating, she said: “With 4Q25 results still rolling in as of mid-February, early indicators suggest mixed outcomes for small caps, which ended 2025 largely flat or down amid subdued demand.
“However, projections show total net profit for FBM Small Cap constituents jumping from RM932.47 in 2025 to RM1.53bil in 2026 – a potential 65% surge – driven by resilient domestic demand and sector rebounds.”
Consequently, she forecast that if 1Q26 beats estimates, especially if it could be driven by consumer discretionary or retail tied to Visit Malaysia 2026 (VM 2026), then this could signal the start of outperformance.
“Remaining 2026 quarters are more promising, with consensus forecasting earnings growth for non-bank FBM KLCI sectors, which could spill over to small caps sensitive to SME activity and manufacturing.
“Stabilising earnings, foreign inflows, and sector rotation could broaden the rally beyond large caps, which could lead to a rebound, with small caps offering better risk-reward as valuations remain attractive,” said the research head.
Offering further insight, Mohd Sedek described his outlook as “cautiously constructive, but very selective” for the FBM Small Caps index, observing that valuations are clearly more attractive after last year’s underperformance.
In addition, he said with large-cap catalysts relatively limited, some rotational interest into small-cap names is likely over time.
“That said, this is not a blanket recovery story. Investors are likely to focus on a balanced mix of value and growth stocks that show clear earnings quality, resilient margins, visible cash flows and sustainable yields, particularly given ongoing geopolitical risks, cost pressures and still-uneven demand conditions.
“In that sense, small caps offer recovery potential as 2026 progresses, but the upside is likely to come through careful stock selection rather than a broad-based re-rating,” Mohd Sedek emphasised.
Of interest, the research head that StarBiz spoke to is expecting the FBM Small Cap to rebound and potentially outperform the FBM KLCI by year-end, aligning with historical patterns in bull markets, despite warning that “it won’t be a straight line as volatility from global events remains a risk”.
Notably, she said the index should track the premier index initially before gaining momentum from April, supported by earnings recovery and thematic tailwinds.
“Themes like infrastructure, initial public offerings, digital transformation, and VM 2026 will boost domestic-sensitive small caps. Ringgit strength ranging from RM3.80 to RM4.00 against the US dollar and resilient demand add tailwinds,” she said.
On the flipside, she warned that fragile broad-based recovery could falter if geopolitical issues continue or earnings disappoint, as the small caps’ higher beta means they are the first to reflect downturns, but also recoveries.
“End-2026, I see the index up 10% to 15% from current levels, outpacing the FBM KLCI’s 3% to 7% projected gain, if catalysts materialise.
This makes small caps attractive for selective exposure, focusing on quality growth stocks rather than passive bets,” she said.
