May's Mayhem Could Bring June Bounce for Small Caps

Whether equities were large or small, the month of May wasn’t kind to either as the U.S.-China trade deal went under and capital markets were quick to react to the news. Small cap equities, in particular, saw a dip as investors favored large cap equities as a safe haven during the heavy bouts of volatility, but June could tell a different story.

That being said, Direxion’s latest Relative Weight Spotlight cites that both large and small are still doing fine–the former up 10.97 percent for the year and the latter 8.65 percent. However, small caps could benefit in June compared to their larger counterparts since they’re not weighed down by growth-oriented names like the FAANG stocks–Facebook, Amazon, Apple, Netflix, and Google–all of which could be subject to more regulatory finger wagging regarding privacy of data and other issues.

“What could provide a boost to Small Caps is simply what they are not; growth-heavy” the Direxion post noted. “The Communication Services and Information Technology sectors are each 6% larger in the Russell 1000 than the Russell 2000. Increased regulatory scrutiny appears to be the new normal for Alphabet, Amazon, Apple, and Facebook that, even if it does not lead to breakups, will be an ongoing distraction and likely force investors to assign them a higher risk premium.”

Can this be an opportunity for small cap strength over large caps?

For investors looking for continued upside in large cap equities over small caps, the Direxion Russell Large Over Small Cap ETF (NYSEArca: RWLS) offers them the ability to benefit not only from large cap equities potentially performing well, but from their outperformance compared to their small cap brethren.

Conversely, if investors believe that small cap equities will outperform large cap equities, the Direxion Russell Small Over Large Cap ETF (NYSEArca: RWSL) provides a means to not only see small cap stocks perform well, but a way to capitalize on their outperformance versus their large cap brethren.

Small Caps a Safe Haven? Think Again

For investors who were looking for an ideal safe haven assets during the U.S.-China trade war, they were better off looking at large cap equities over small cap equities, according to Jill Carey Hall, the resident small cap stock expert at Bank of America. Hall said that small cap fundamentals are suspect and as such, should be avoided if a prolonged trade war continues.

“A lot of these companies are suppliers to the big multinationals. Many of them have been highlighting the impact of trade on calls this earnings season,” said Hall. “A lot of these companies might not be able to be as nimble about shifting their supply chains or pricing that through.”

The Russell 2000–the index primarily associated with small cap equities–is up 21 percent since December’s sell-off during a volatile fourth quarter in 2018. However, the index is in correction mode with a drop of 12 percent after hitting a high last summer.

“Small cap earnings have been coming in in-line with expectations. You’ve seen much fewer beats. You’ve seen negative earnings growth,” said Hall. “Typically, you would think of small caps as higher growth companies, but expectations have been really ratcheted down.”

Small cap equities were practically neck and neck with large cap equities during the month of April. Year-to-date performance for U.S. equities have been fueling both large cap and small cap stocks, as both jockeyed for position during that month.

Thanks to a more accommodating central bank in terms of interest rate policy, the markets have been able to fend off other macro fears like slower global growth. More help came from the U.S. economy rebounding in the first quarter this year, as it beat analysts’ expectations of 2.5 percent growth with a 3.2 percent growth number.

For more relative market trends, visit our Relative Value Channel.