Investors have never been more excited about small caps

Myles Udland
·Markets Reporter
·4 min read

Wednesday, January 20, 2021

A version of this article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Bigger is not better in this market.

Things happen quickly in the stock market these days.

And so you’d be forgiven for thinking that this market rally is still all about a few big tech stocks or a couple of buzzy pandemic winners.

Except that for the last few months, these have not been major market drivers.

The speculative energy has come from SPACs, electric vehicle plays, and renewables. And expectations for more stimulus, faster growth, and vaccines in the arms of Americans have been expressed through the recent rally in small caps.

Since the stock market bottomed on March 23, the small cap Russell 2000 (^RUT) — which houses the 1,000th through 3,000th largest stocks in the market — has more than doubled, rising some 114%, while the Nasdaq (^IXIC) is up about 90% and the S&P 500 (^GSPC) has risen “just” 65% over that time.

The small cap Russell 2000 has more than doubled from the March 23 market lows and soundly outperformed both the tech-heavy Nasdaq and the benchmark S&P 500 during that time.
The small cap Russell 2000 has more than doubled from the March 23 market lows and soundly outperformed both the tech-heavy Nasdaq and the benchmark S&P 500 during that time.

The divergence in performance among these indexes has been even more pronounced since the late-October trough during the market’s pre-election swoon. Since Nov. 1, 2020, the Russell 2000 is up 39%, outperforming both the Nasdaq and S&P 500 by more than 20 percentage points each.

And investors think this momentum will continue.

In its latest global fund manager survey published Tuesday, Bank of America Global Research found the number of investors who think small caps will outperform big cap stocks in the next 12 months remains at a record high.

Bank of America's latest global fund manager survey shows expectations for small cap stocks continues to be at a record high. (Source: Bank of America Global Research)
Bank of America's latest global fund manager survey shows expectations for small cap stocks continues to be at a record high. (Source: Bank of America Global Research)

The Russell 2000 is more weighted to sectors like financials and industrials, which are seen as winners in the beginning of economic cycles. Since Nov. 1, the KBW Bank Index (^BKX) is up nearly 40%. The XLI ETF (XLI) that tracks the Industrial sector is up about 17% over this same period, outperforming the S&P 500 by about 2 percentage points though underperforming the overall Russell 2000. Financials and industrials each account for about 15% of the Russell’s market cap. Health care, at around 21%, is the index’s largest sector.

The S&P 500, in contrast, has a 27% weighting to the technology sector (XLK), which includes Apple (AAPL) and Microsoft (MSFT), which both sport market caps north of $1.6 trillion. The Russell’s tech weighting is closer to 14%. Communications services (XLC) also accounts for about 2% of the Russell 2000 but more than 10% of the S&P 500, with Alphabet (GOOGL), Facebook (FB), and Netflix (NFLX) all members of this industry group.

Outside these sector weightings, the Russell is also more levered to the success of the U.S. economy with more than three-quarters of revenue brought in by index members coming from the domestic economy. In contrast, S&P 500 members bring in less than two-thirds of total revenues from the U.S.

And so if the U.S. economy is indeed beginning a new economic growth cycle and the stock market is entering a new bull market, then this bet makes sense.

Banks should benefit from rising interest rates and a growing economy. Indeed, Goldman Sachs raised its forecast for economic growth over the weekend to 6.6% growth in 2021 from 6.4%.

Additional fiscal stimulus and (gasp!) an infrastructure bill might boost industrials and just about any business that gets most of its revenue from the U.S.

And if the Biden administration does indeed deliver — or overshoot — on its goal of 100 million COVID-19 vaccines in its first 100 days, then the economy may exceed expectations in 2021.

All of which sounds great to us here at the Morning Brief. Vacations, gatherings with friends, and a return to the Yahoo Finance studio this year is appealing all around.

Let us hope then that the small cap trade doesn’t let us down.

By Myles Udland, a reporter and anchor for Yahoo Finance Live. Follow him at @MylesUdland

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