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A Small Cap Cornucopia

Small cap stocks in the US have been on a tear since early September and really since last March. The Russell 2000 is up 137% over the past year and nearly 47% since early September. What has particularly stood out is the outperformance versus the S&P 500, which is up 68% from a year ago and about 11% since September. The chart below displays the ratio of the Russell 2000 level (small cap stocks) to the S&P 500 level (large cap stocks). A rising line indicates the Russell 2000 is outperforming while a declining line indicates the S&P 500 is outperforming.

A few observations:

  1. The recent run up in small cap stocks relative to large cap stocks is pretty amazing in the context of the historical data set. We observed something similar after the events of Black Monday in October 1987, only to see the downtrend in small cap stocks relative to large cap stocks break to the downside to a lower low.
  2. The long period of small cap stock outperformance that began in early 1999, started from an all-time low level of relative performance and presumably an extreme relative valuation spread to larger cap stocks, especially technology stocks.
  3. The nadir in November 1990 happened to coincide with the nadir of the 1990 recession while the nadir in April 1999 was about a year before the peak in the Nasdaq.

Takeaways:

  1. Small cap stocks are getting close to their 2014 peak outperformance relative to large caps (for this century), begging the question of how much longer this move has to run.
  2. If economic growth doesn’t meet expectations, small cap stocks may take the brunt of any fallout.
  3. Similar to other value stocks, small cap value stocks have a lot of ground to potentially make up against small cap growth stocks (see chart below).
  4. The move in small cap stocks over the past year is a good example of why you should always have small cap exposure in your portfolio. You can’t predict when moves like we’ve witnessed over the past year are going to occur, and you don’t want to miss out on that type of relative outperformance in your portfolio.

Fundamental Chart Chart