Small Caps Charge, Augurs Well For The Stock Market

May 22, 2018 10:11 AM ETAAPL, ADAP, AMZN, AXON-OLD, CBIO, CHGG, CRSP, CRZO, ECYT, ENVA, META, FOSL, GDS, GES, GOOGL, GTHX, HRTX, INTEQ, IMMU, IWM, LOXO, MRTX, MSFT, NFLX, NVDA, QCP, QQQ, QURE, SFLY, SPY, SRPT, TWLO, WTI9 Comments

Summary

  • Small cap stocks record fresh all-time highs leading the broader market indexes higher for the first time in a couple of years.
  • Small cap performance suggests an underlying risk appetite in the market even with the volatility and yield-related concerns.
  • Markets trends are reinforced, not weakened, when small caps are leading markets.
  • Small cap stocks have a long-term track record of outpacing larger caps.
  • A disciplined strategy with a prudent portfolio allocation to the small and mid cap segment can make a significant difference to long term returns.

Finally, Small Caps Lead the Charge

It is the first time in over a year that small cap stocks have led the broader market to a new all-time high. This relative outperformance suggests something important.

Markets don't turn over and change primary trends when small caps are making new all-time highs.

Small caps are a good barometer for risk appetite and the new highs indicate the presence of a broader willingness towards risk-taking. In a market jolted by volatility and living through an onerous and somewhat exaggerated fear of rising yields, the small-cap stocks are acquitting themselves better than their larger cap peers. As investors have become accustomed to a market being consistently led by a group of mega caps like Amazon (AMZN), Alphabet (GOOGL), Facebook (FB), Apple (AAPL), Netflix (NFLX), Nvidia (NVDA) and Microsoft (MSFT), the small cap rally being witnessed this month is a pleasant departure and provides a more democratic tenor to the bull market.

In the last 2 out of 3 years, small caps have been delivering a more muted performance, and it has been the larger-cap focused indexes like the S&P 500 (SPY) and Nasdaq (QQQ) that have outshined.

Investment Performance ~ Source: Graycell AdvisorsGraycellAdvisors.com ~ Stock Market Performance 2015 - 2018

However, this is beginning to change.

Perhaps, a period of lagging performance could now be giving way to a reversion towards mean, whereby small cap indexes outperform for some time to come as they revert to their leadership position.

As we mentioned in our earlier article, Small Caps the Bright Spot, there are some unique aspects to small caps, which in the current environment are benefitting more directly than the larger cap stocks.

5 Reasons For Small Caps Improving Performance

First, the small cap companies have a more direct exposure to the fortunes of the US economy, relative to larger companies which

This article was written by

Tarun Chandra, CFA profile picture
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A healthcare growth portfolio with a record of consistently strong returns

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