The Russell 2000 Index and the S&P SmallCap 600 Index are up 4% and 1.7%, respectively, year-to-date, confirming the laggard status of smaller U.S. stocks. Those performances pale in comparison to the 9% returned by the S&P 500, weighing on ETFs such as the SPDR Russell 2000 ETF (NYSEARCA:TWOK) and the SPDR S&P 600 Small Cap ETF (NYSEARCA:SLY).
Small-cap weakness is prompting some professional investors to increase bearish bets against the asset class, particularly as doubts increase about the ability of President Donald Trump to push forward key parts of his domestic economic agenda that were seen as catalysts for smaller stocks.
“One measure of market breadth we monitor is the number of stocks that are trading above a defined price. Small caps notably benefited from the “Trump Bump” after the election; however, small-cap performance has waned as a result of the delayed policy agenda,” notes State Street Global Advisors (SSgA). “While the small-cap Russell 2000 Index continues to chug along, registering a new all-time high on June 13th, not all small-cap stocks are being lifted by the tide.”
Small-caps are also focused on the domestic economy and have less direct exposure to global geopolitical uncertainty and currency risks, as opposed to large-cap companies that have an international footprint, which may be affected by overseas risks and a strengthening U.S. dollar.
“Only 67% of small-cap stocks are trading above their post-election price (11/9/2016), and less than half are trading above their 2016 year-end price. If a bout of volatility strikes the market leaders, there will be little support from the small-cap masses to keep the Russell 2000 Index all-time highs afloat,” according to SSgA.
Related: Russell Index ETFs’ Reconstitutions Reveal After Effects of Post-Election Rally
Additionally, periods of rising rates also coincide with expanding economies, which often benefit smaller companies. However, the dollar is sagging this year and the Federal Reserve could be forced to hold off on more rate hikes, scenarios that are pressuring small-caps.
“We’re seeing a divergence in 2017 earnings growth estimates. While large-cap estimates have turned higher, small-cap stock earnings estimates continue to head south. If we see a summer stock market swoon, small caps may not be able to rely on earnings growth as a life raft—all at a time when valuations are in the upper 80th percentile based on the last 22 years of data,” adds SSgA.
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