What is (not) up with small cap stocks?

We want to make a point, but we should provide a bit of background first…

The most common benchmark used to measure the performance of small cap stocks is the Russell 2000 Index. It is comprised of the smallest 2000 stocks of the Russell 3000 index, which represents the performance of the largest 3,000 publicly held US companies, based on their total market capitalization. According to the FTSE Russell website, www.ftse.com, the average market cap of the Russell 2000 is $2.08 billion, and the median market cap is $800 million. These are big companies, but not in comparison to the large cap stocks. You may not recognize any of the top ten holdings in the Russell 2000. The top three? Kite Pharma, Gramercy Property Trust and MKS Instruments.

The most common benchmark used to measure the performance of large cap stocks is the S&P 500 index. It is comprised of 500 large publicly held US companies, traded on either the NYSE or NASDAQ stock exchange, as selected by committee, based on meeting certain criteria. It is widely considered to be the best indicator of the US economy. According to the S&P Dow Jones website, www.us.spindices.com, the average market cap of the S&P 500 index is $43.98 billion, and the median market cap is $20.61 billion. You would probably recognize all top ten holdings in the S&P 500. The top five are Apple, Microsoft, Facebook, Amazon and Johnson & Johnson.

Based on what we hear in the media, the ‘market’ is booming. The Dow 30 and S&P 500 are near record highs. The labor market is at full capacity. Year to date, through 8/22/17, the S&P 500 index was up 10.99%. The economy should be healthy and growing. Yet, the Federal Reserve Board remains reluctant to raise interest rates. Wage growth is stagnant. The inflation rate remains under 2%. Where is the disconnect between perception and reality? Which is which?

The current market environment seems to favor large, global companies. While these mega cap companies are reflective of our economy, and they most certainly move the markets, they do not paint the entire picture. Year to date through 8/22/17, the Russell 2000 index, the small cap index, was only up 1.87%. That is a substantial lag behind the S&P’s 10.99%. Why are the small caps so far behind the large caps this year?

In 2016, the Russell 2000 outpaced the S&P 500, with an annual return of 21.31% compared to the S&P’s 11.96%. The boom in small cap performance last year was attributed by many to the ‘Trump Trade’ – an expectation that the new administration would enact legislation that would reduce corporate taxes, reduce and eliminate onerous banking regulations, and revamp an ailing healthcare system. The opportunities for small businesses seemed promising in that environment. Due to current political uncertainties, that future is much less certain. It could be that we are seeing an unwinding of the ‘Trump Trade’, and it is showing up first in the Russell 2000 index.

Going forward, it is anybody’s guess as to whether the small caps will reach up to join the large caps, or the large caps will fall back to join the small caps, or they will each head in different directions. We will continue to watch the markets to see if we can discern a clear signal that the economy is healthy and growing strong. If nothing else, this divergence in performance of two of the most followed US indices shows the importance of being invested in both.

- Bryant & Brannock 8-23-17