The Small Cap Reign May Be Over

by: Market Blog

By David Berman

Here’s a big victory for small-cap U.S. stocks: On Wednesday, the Russell 2000 index touched its highest level since October 2007.

Consider the implications. The index has fully recovered not only from the 6.3% dip that began in February, but also recovered from the devastating bear market that followed the financial crisis and recession. (It has another 2% to go before the index hits a record-high level.)

The index, which consists of the 2,000 smallest stocks within the Russell 3000, is a benchmark for small-cap stocks given that the average market capitalization is just $1.4 billion (U.S.). By comparison, the average market cap within the S&P 500 is $27 billion.

The Russell's incredible ascent – up 144% from its 2009 low – reflects how smaller companies have benefited from the economic recovery and stimulus policies, including ultra-low interest rates from the Federal Reserve. By comparison, the S&P 500 has risen 97% from its 2009 low (yeah, that’s a lot, but it trails the Russell 2000 by a lot too: 47 percentage points). As well, the S&P 500 is still trying to recover from that February dip and has to climb another 15% before it hits 2007 territory.

Clearly, small-cap stocks have been the place to be over the past two years. But will they be the place to be for the next two years?

Some observers have pointed out that large-cap stocks offer a more attractive valuation at this point, which could be an important factor in an era of rising interest rates. The price-to-earnings ratio for the S&P 500 is just 15.6, while the P/E on the Russell 2000 is about double that. The S&P 500 offers a more attractive dividend yield as well, at 1.8% versus 1.3% for the Russell 2000.

Disclosure: None