Big Percentages, Smaller Dollars

by: Bespoke Investment Group

The decline in small-cap stocks relative to their larger brethren has been pretty dramatic recently, and it's a topic we've posted on before. But what does it mean for the market as a whole? We think some context is necessary before evaluating how harmful the big losses in smaller cap stocks and internet firms is for market psychology as a whole.

Below is a table showing the market cap for several major indices. The Russell 1000 index tracks large-cap stocks similar to the S&P 500, while the Russell 2000 index is focused on smaller firms. The Nasdaq Composite is also weighted to smaller firms, while the Nasdaq Internet Index is diverse in terms of the size of companies but weighted heavily toward the type of firm that has been smoked in the recent pain trading for momentum stocks.

As shown below, the 1,000 stocks in the Russell 1,000 make up about $20 trillion in market cap, while the 2,000 stocks in the Russell 2,000 make up just $2 trillion in market cap. From their peaks, the Russell 1,000 has lost $265 billion in market cap while the Russell 2,000 has lost $155 billion in market cap. While these drops in market cap are pretty similar, in percentage terms, they're very different. The Russell 1,000's drop in market cap is just 1.3%, while the Russell 2,000's drop in market cap is 7.4%.

The bubble chart below shows the same information in a different presentation. The horizontal axis shows the decline in terms of dollars since the peak of each index, while the vertical axis measures percentage declines. Bubble size is the market cap of each index at their peak. Despite being the worst and third-worst performers in percentage terms, the Internet stocks and Russell 2000 are off by the least in dollar terms. Meanwhile large cap indices that are only down modestly from recent highs are bigger losers.

Our point here is that huge percentage declines aren't always a threat to the market as a whole. Another important factor is the total size of the decline. Putting that in context helps explain why outsized percentage declines in go-go momentum stocks or speculative internet plays haven't spilled over to similarly painful percentage drops in large cap stocks... the large caps are just too big relative to small caps for the pain trade to be the most dominant factor in their performance.