A Study in Smallcaps

Smallcaps have outperformed largecaps by 7.60% over the last 1-month. As the big names like Microsoft and Nvidia are selling off, smallcap stocks such as Piper Sandler and Cohen & Steers are reaching new highs. This spurt of smallcap outperformance follows a year dominated by the largecaps. And I mean absolutely dominated. Prior to this month, the S&P 600 Smallcap Index was displaying a negative year-to-date return and underperforming the S&P 500 Largecaps by nearly 20%.

Now, a few weeks does not make a trend. Both the smallcap absolute price chart and relative price ratio (versus largecaps) have a lot of work to do. But the recent move in US Smallcaps is not to be understated. We’re coming off the best week for smallcaps relative to largecaps since March 2020.

Valuation is also in favor of small over large. As the smallcap forward price to earnings (P/E) ratio is well below its long-term average. Largecap forward P/E is well above its long-term average. In other words, the smallcap (largecap) index is cheap (expensive) relative to its historic average valuation.

This market rotation is a great opportunity for investors to deepen their understanding of smallcaps or the size factor. There are amazing resources online including here and here.

A good question to ask ourselves: What should we expect from other equity categories if small is outperforming large?

Well for starters, Bank stocks are the largest weighted industry in the Russell 2000 Smallcap Index. If smallcaps are outperforming, it is likely that Financials sector stocks of all market cap sizes are doing relatively well. To couple the rotation into smallcaps, we’re seeing a change of flows away from large Technology and into large Financials.

If Financials are outperforming Technology, it is likely that Value equity is holding up better than Growth. Financials are the largest weighted sector in most Value equity indices. Over the last 1-month, Value is outperforming Growth by over 4.50%.

Smallcaps are hinting at what new leadership may look like. Whether or not we actually witness a long-lasting change in market leadership is to be determined. Again, a few weeks does not make a trend (or change of trend). Nonetheless, the move in smallcaps is extremely notable. It highlights both increased risk appetite among investors and increased participation among stocks.

That’s enough out of me!

SM

All indices are unmanaged, and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results.