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Small-Caps Are Back in the Driver's Seat

20 June 2013 in Trading Ideas

The performance competition this year between large-cap and small-cap stocks has been close all year, but the recent race ahead by small-caps is a bullish sign for some market analysts.

At the beginning of this week, small caps outpaced the S&P 500 Index by about 6%; however, in the last 3 days, small caps have pulled back but maintained a slight edge over the broader market.

At the close of trading on Friday, the small-cap Russell 2000 Index had increased 10.2%. The broader S&P 500 Index, meanwhile is up 10.0%.

Our Small-Cap Stars motif, a portfolio of 25 stocks of companies with demonstrated strong earnings growth and cash flows over the past five years, has increased 5.6% in the past three months and 8.1% since the motif was created on March 5, 2013.

However, in just the past month, the motif has risen 1.7%, compared with the S&P 500’s decline of -3.4%.

small-cap stars

That sort of outperformance by small-caps has, in fact, been playing out over the past two months – since April 19, the Russell 2000 has climbed 9.68% while the S&P 500 has risen 3.45%.

For InvestorPlace writer Dan Burrows, this is a welcome sign. He believes that with bond prices recently falling and yields rising, large-cap dividend stocks have lost some of their appeal. Additionally, the selloff in bonds has helped money flow out of debt and into equities, helping small-caps along the way.1

And, Burrows, says, small-cap leadership is what you want in a rising market because it usually means that “investors are embracing riskier, more speculative bets, which in turn helps make the case for stocks in general.”

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In addition, there could be fundamentally sound reasons to expect small-cap outperformance to continue. As the Wall Street Journal reported last month, Bank of America analyst Steven Desanctis is calling for the S&P Small-Cap 600 Index to post earnings-per-share growth of 12% to 15% this year.2 Meanwhile, Desanctis was looking at growth for S&P 500 companies at 6% to 7%.

“Right now, there seems to be a big enough difference in expected growth rates [compared to large caps] to make it worth paying up for small caps,” Desanctis told the Journal.

But even continued outperformance doesn’t guarantee that prices are going up. It’s possibly instructive for investors to remember that the current lull in large-cap stocks (down 1.2% since May 22) has been similarly seen in small-caps (down 0.6%), if not our own Small-Cap Stars motif. More recently, the Federal Reserve’s remark that it may begin to wind down its stimulus plan has put a damper on the overall market, which can have a greater impact on the smallcaps.

As always, losing money is still losing money.

1Dan Burrows, “A Point for the Bulls: Small-Cap Stocks Reclaim Leadership,” investorplace.com, June 12, 2013, http://investorplace.com/2013/06/a-point-for-the-bulls-small-cap-stocks-reclaim-leadership/, (accessed June 19, 2013).

2Murray Coleman, “Small Caps Battle for Market Leadership,” WSJ.com, May 17, 2013.