U.S. Small Cap Stocks Continue To Set New Highs

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by: James Picerno

The S&P 500 briefly traded in record territory yesterday before closing just below an all-time peak. Small-cap stocks, however, had no trouble setting new highs.

The Russell 2000, a widely followed small-cap benchmark, pushed further into record territory on Tuesday, August 21. The S&P 600, another popular small-cap index, also set a new all-time high.

Comparing small caps against the broad market via the S&P 500 ($SPX) this year reveals that the lower end of the equities spectrum continues to lead by a wide margin. The Russell 2000 ($RUT) is up 11.9% year to date, a hefty premium over the S&P 500's 7.1% gain so far this year. The S&P 600 ($SML) is up even more, posting a sizzling 16.9% year-to-date performance.

Will the rally continue? Positive momentum suggests there's still room to run. All three indexes are above their respective 50- and 200-day moving averages and the 50-day averages are well above their 200-day counterparts.

There's also a healthy tailwind blowing with earnings, advises Richard Turnill, BlackRock's global chief investment strategist. "Firms beating expectations have been rewarded with rising stock prices, even as investors fret about rising economic uncertainty, trade frictions and a strong U.S. dollar," he noted recently. "Our analysis of corporate guidance suggests company confidence is on the rise - giving us conviction that earnings strength can power on in 2018 amid solid global growth."

Analysts say that small caps are drawing strength from a tax cut that's juiced US economic growth this year. GDP growth accelerated to 4.1% in the second quarter, nearly double Q1's pace. The outlook for Q3 is upbeat, too. The Atlanta Fed's nowcasting model is especially bullish, projecting that output will tick even higher to 4.3% in the current quarter (as of the August 16 estimate). Now-casting.com's August 17 outlook called for a softer 3.3% rise, but that's still a solid gain.

In any case, US recession risk is virtually these days, and the immediate future looks set to deliver more of the same, as outlined in last week's US business cycle risk report.

Meantime, the crowd is reportedly looking to small caps as a safe haven of sorts in the equity space. With a tighter focus on the domestic market, smaller firms based in the US are seen as relatively insulated from the trade war that's been developing between the US vs. China and Europe.

If there's a joker in the deck, it may be political risk. Yesterday's news that President Trump's former personal lawyer, Michael Cohen, pleaded guilty to taking direction from Trump to pay two women to remain silent in the 2016 campaign regarding affairs they claimed to have had with Trump. Adding to the president's legal worries: yesterday's conviction of former Trump campaign chairman Paul Manafort on several counts of bank and tax fraud.

Politico reports that the legal developments may fuel momentum for impeachment by the Democrats, assuming they take back the House of Representatives in this fall's elections. "This just underscores the importance of the midterms and keeping the House," a Republican close to the White House opined. "If Nancy Pelosi is speaker, Donald Trump will face impeachment."

Politics aside, one can argue that the good news is already priced in for small-cap stocks, and so the easy money has been made. Perhaps, but a healthy US macro trend boosts the odds that any short-term bumps for equities will be temporary.

"As long as the U.S. economy is strong and growing, the job market is stable and growing, and corporate earnings are strong and growing, the market should be and will continue to be strong," predicts Jamie Cox, managing partner at Harris Financial.