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Small-Caps Are Back On Center Stage

12 July 2013 in Trading Ideas

After a mini-correction of about five weeks, the stock market has returned to its upward trajectory, for now. And nowhere is that more true than in the recent re-embrace by investors for small-cap stocks.

While the year has been close to a wash between the large-cap S&P 500 Index and the small-cap Russell 2000 Index (the S&P is up 15.7%, while the Russell 2000 has gained 16.1%), the market’s uptick in volatility over the past two months has spotlighted once again that performance gaps can widen between the two classes of stocks with regular frequency.

In the past two weeks, for example, small-cap stocks have nearly doubled the performance of their larger-cap siblings (S&P’s 2.9% gain to the Russell’s 5.5% rise). And over the past two months, which has included two mini-bull runs by all stocks, the Russell is up 7.4% to the S&P’s 3.9%.

This recent performance has been echoed by the Small-Cap Stars motif, which is up 7.3% in the past 30 days. During that same timeframe, the S&P 500 has gained 1.6%. Since the motif’s creation March 5, 2013, it’s up 15.4%. The S&P 500 has gained 7.8% in that period while the Russell 2000 has gained 9.77%.

small-cap stars

(The Small-Cap Stars motif isn’t a broad index portfolio – it comprises 25 indivudual stocks that have been selected in part due to demonstrated strong earnings growth and cash-flow performance by the underlying companies over the past five years.)

So, what’s behind the mini-run in small-cap stocks? A couple of thoughtful comments recently were offered by the folks at Bespoke Investment Group. For starters, it’s worth noting that the drug and biotech sector of the Russell 2000 had climbed more than 11% from May 22, to July 8. Bespoke suggesting that the main trigger was the rise in many cancer-related small-cap stocks in the wake of the annual ASCO conference in June – a much-anticipated annual event for biotech investors.1

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Second, it may be as much about where US small-cap companies tend to focus their business – that is, here in the US, and not in the many global markets that are struggling with slowing growth, or no growth at all. As Bespoke notes, the recent outperformance by small-caps suggests that investors are increasingly encouraging the group to stick with US companies with domestic exposure.2

All of which means the recent outperformance of small-cap stocks could give way at any moment. On the other hand, minimizing exposure to small-caps during the runup in equities over the past two years hasn’t been a productive strategy.

1“New All Time Highs For Russell 2000,” Bespoke Investment Group blog, July 8, 2013, http://www.bespokeinvest.com/thinkbig/2013/7/8/new-all-time-highs-for-russell-2000.html.

2“The Big ‘Small’ Rally,” Bespoke Investment Group blog, July 8, 2013.