Small Caps Start Climbing, at Long Last | Chief Investment Officer

The current upswing in small stocks may actually be real. Previous such rallies have fizzled, due to huge tech momentum players seemingly vacuuming every spare investment dollar.

Small caps, which enjoyed a brief spurt in May and June, only to recede, have been on a roll since the beginning of the fourth quarter. Year-to-date, the Russell 2000, the best-known benchmark for the small-fry, trails the large-cap S&P 500 by five percentage points (21.2% versus 25.5%). But since October 1, the Russell index has pulled ahead by one point.

Avalon Advisors sees “significant evidence” that the small-cap outperformance may well continue this time. Namely, price. “Valuations are attractive and currently stand at over two standard deviations cheaper relative to the S&P 500,” the firm writes in its weekly newsletter.

What’s more, it’s telling that the Russell 2000 last week reached its first 52-week high in more than a year. Such a feat, in 10 out of 11 similar situations since 1982, resulted in an average gain of 15.2%, according to Strategas Research Partners. And Bank of America Merrill Lynch predicts a switch in leadership from large-to-small-caps in 2020, as the economy keeps growing (that’s assuming it does). This gives skittish investors confidence to try small stocks.

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A lot of the optimistic case for small caps rests on how two of the Russell indexes largest components, financial services and biotech, fare. They have had their troubles. And earnings per share for the Russell benchmark have fallen 2.5% this year, Citigroup notes.

Still, who knows? The last may yet be first.