Small-capitalization stocks and related exchange traded funds have slowed recently when compared to their large-cap counterpart, but smaller companies may have more wiggle room to grow.
So far in December, the Russell 2000 Index, the underlying benchmark for the widely monitored iShares Russell 2000 ETF (NYSEArca: IWM), has dipped 1.5%, but FTSE Russell remains optimistic over the small-cap category’s outlook.
“The Russell 2000 Index has a return of nearly 27% since the US presidential election last November, outperforming other major US cap tiers,” Tom Goodwin, senior research director for FTSE Russell, said in a note. “And this is without the benefit of the new administration having passed any significant new legislation.”
A way to interpret the current market conditions among small-cap stocks is by the length and breadth of their performance. Looking at historical data, Goodwin also found that small cap cycles since 1978 showed the current Russell 2000 Index generated an uptrend of a 31% annualized return and 63.5% absolute return in the 464 trading days since February 11, 2016.
“The 11 small cap up cycles since 1978 saw a median return of 106.8% over a median period of 698 trading days,” Goodwin said. “This suggests there is still room on the upside for the index.”
Along with the performance context on a historical basis, Goodwin notes a number of additional supporting factors that may keep US small caps going.
“While some investors are concerned about potentially high valuations for US small caps in this extended bull market for US stocks, the current price-to-book ratio for the Russell 2000 Index is nowhere near its all-time high. In addition, implied volatility for US small caps as measured by the CBOE Russell 2000 Volatility IndexSM is at its lowest point since the Index was launched in 2004,” Goodwin added.
When looking at the price-to-earnings ratio and also accounting for inflation, the Russell 2000 is actually trading below its historical mean but still well within its historical one-standard-deviation band.
A high expected volatility would be a signal for hurdles to come, but the current CBOE Russell 2000 Volatility Index shows forward looking options are currently hovering near historically low levels or are reflecting a relatively subdued volatility outlook.
For more information on the small-capitalization market, visit our small-cap category.