Small-cap stocks are having a very strong 2021 so far.
Through the first two months of the new year, small-caps have been
outperforming large-caps by the largest margin in over two decades. And when I
say large margin, I mean really large
margin – year-to-date through March 16, small-caps have outperformed large-caps by 15%.1
There is plenty of historical data suggesting that over long
periods, small-cap stocks tend to edge out large-caps on an annualized basis.
It’s usually referred to as the “size effect,” and tends to be narrow but still
meaningful over time. So, while small-caps’ recent outperformance over
large-caps is nothing new, the sheer size of the outperformance gap is worth
noting and asking a few questions about.
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How Long Will the Economic Expansion and Bull Market Last?
The stock market has been signaling a strong economic
recovery in the months ahead. Many investors may be wondering how much more
upside is possible in 2021? But there is no way of knowing how long this surge
could last. Instead of focusing on the “what if’s”, I recommend focusing on the
hard data and economic indicators that could impact your investments in the
long-term.
To help you do this, I am offering all readers our
just-released Stock Market Outlook report. This report contains some of our key
forecasts to consider such as:
- S&P
500 earnings growth
- Outlook
for underlying U.S. economy?
- U.S.
returns expectations for 2021
- What
produces 2021 optimism?
- Is
it time to buy U.S. stocks?
- Update
on U.S. fiscal stimulus
- And
much more…
If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today!
IT’S FREE. Download the Just-Released April 2021 Stock Market Outlook2
First, is there a reason for this outperformance?
I think one reason for the outperformance is tied to the
‘value-over-growth’ theme I’ve written about recently. Small-cap stocks are
currently closer to the value end of the spectrum than large-cap stocks. If we
define value stocks as having low price to per-share book value ratios relative
to their growth counterparts, then small-caps are looking like the value in the
current environment while large- and mega-caps are looking like growth stocks.
The price to per-share book value ratio of the Russell Top
50 Mega-Cap Index is 5.7x (through the end of February), the Russell 1000 Index
(largest 1,000 stocks) is 4.2x, and the Russell 2000 Index (small caps) is
2.5x. Investors can find value in small-caps.
One of the reasons for the rotation from growth to value is mean
reversion. Since 2007, the outperformance of growth relative to value has
approached levels not seen since the 1930s and the dot com bubble. In fact, the
spread between the price-to-earnings (P/E) ratio on growth and the P/E ratio on
value stocks is the highest it has been since 2000, when the bubble burst on
many growth names.3 This makes value stocks look attractive relative
to growth stocks, which again has been a tailwind for small-caps, in my view.
Another value-oriented benefit for small caps: rising interest rates
and the possibility of inflation. Expectations of higher inflation tend to push
long-term interest rates higher, which has been impacting areas of the market
with relatively high P/E ratios (i.e., growth). This could mean a reality check
for many high-flying technology and other growth names, and could trigger an
investor rotation into value, benefiting small-caps in the process.
One final reason for small-caps doing well, in my view – we’re in the early days of a new economic expansion and bull market. The stock market has been signaling a strong economic recovery in the months ahead, and small-cap stocks have historically done well early in a new cycle when liquidity is cheap and overall growth rates are faster. There is no way of knowing how long this initial surge could last, but I like small-cap exposure as part of a broadly diversified equity portfolio right now.
At Zacks Investment Management, our Small-Cap Equity Strategy
screens all 2000 stocks in the Russell 2000 Small-Cap Index, and we access the
power of our own industry-leading research firm to construct a portfolio of
about 100 stocks. Our research process and data-driven decision-making means
that if any one of the stocks exhibits declining fundamentals, we’ll sell it.
Bottom Line for
Investors
Small-caps have had a strong run relative to large-cap
stocks, particularly within the value vs. growth realm. While no one can know
for sure how long the outperformance might last, I think carefully selected
small-cap stocks can be beneficial as part of a broadly diversified portfolio
of equities (assuming your goals and risk tolerance allow for it). I also think
this economic expansion has plenty of room to run, and small-caps could benefit
from rapid growth in the early phases. The Zacks Small-Cap Equity Strategy is
an option to consider when positioning for this potential growth.
In addition to maintaining a diversified portfolio, I recommend focusing on key data points and economic indicators that could positively impact your investments in the future. To guide you, I am offering all readers our Just-Released April 2021 Stock Market Outlook Report.
This report looks at several factors that are producing optimism right now and contains some of our key forecasts to consider such as:
- S&P
500 earnings growth
- Outlook
for underlying U.S. economy?
- U.S.
returns expectations for 2021
- What
produces 2021 optimism?
- Is
it time to buy U.S. stocks?
- Update
on U.S. fiscal stimulus
- And
much more…
If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today!
Disclosure
1 Wall Street Journal. March 6, 2021. https://www.wsj.com/articles/how-to-understand-the-small-stock-rally-11615026601?mod=djemMoneyBeat_us
2 Zacks Investment Management reserves the right to amend the terms or rescind the free Stock Market Outlook offer at any time and for any reason at its discretion.
3 Forbes. November 12, 2020. https://www.forbes.com/advisor/investing/value-vs-growth-stocks-performance/
4 Zacks Investment Management reserves the right to amend the terms or rescind the free Stock Market Outlook offer at any time and for any reason at its discretion.
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