Resurge. Following a rather rocky year, smallcap stocks are bouncing back. Over the summer, investors were dumping their riskier stocks as a result of persistent trade tensions. They are now attempting to diversify their portfolios and stay away from index overlap by pouring capital into relatively cheaper-priced equities. The iShares Russell 2000 ETF, which tracks the benchmark index for smallcap stocks, saw its largest weekly inflows in nearly a year earlier this month. When looking at month-to-date, the Russell 2000 has advanced 6.4%, while the S&P 500 only rose 2.4%. These stocks are good from a growth perspective, because when fear sent money flowing into safer securities, it pushed down the value of these assets. Economists now predict that smallcap stocks will outperform largecaps by more than 6% over the next year.

Rate Cut Benefits. In the past, smallcaps have outperformed the market following a rate cut. Historical data show that in the first three months following a rate reduction, smallcaps over-perform largecaps by 6% and within twelve months, they normally outperform by about 13%. Jeffries equity strategist Steven DeSanctis predicts that the Russell 2000 will benefit from the rates being lowered for the second time this year and feels an aggressive Fed should ramp up smallcaps. He stated that the lower rates would help the housing market, which would produce higher returns for smallcaps, as 30% of earnings are from housing-related industries, compared to only 12% for largecaps.

Remain Behind. Although the Russell 2000 has recently seen a dramatic jump, it still has fallen more in the last year than the largecap benchmark, the S&P 500. Over the past year, the Russell 2000 index is down more than 7% while the S&P 500 is up nearly 4%. Before this past month, the smallcap fund valuation was down lower than it had been in more than 15 years. Only one smallcap fund saw positive returns in the past year.

Time for a Comeback. Smallcap funds have the ability to be a driving growth factor in the upcoming year. Interest rate cuts will only take them so far, but sustained rally and healthy earnings can push them beyond the 2018 peak. When compared to the market low cap stocks are still behind year-to-date, but because indexes have seen a drastic increase in capital inflow, they have been overvalued and are now expected to underperform smallcap funds next year.

Sources:

https://www.investopedia.com/why-money-is-rushing-into-small-cap-stocks-and-etfs-4769976, Matthew Johnston, September 14, 2019

https://www.marketwatch.com/story/the-dow-and-sp-500-havent-been-this-walloped-by-small-caps-since-2016-2019-09-11, Mark DeCambre, September 11, 2019

https://www.marketwatch.com/story/small-cap-rally-why-this-week-will-be-make-or-break-for-the-russell-2000-2019-09-17, Chris Matthews, September 17, 2019