Smaller company stocks are typically seen as more risky when compared to their larger peers, but more recently, small-cap stocks and related ETFs are exhibiting volatility at record lows relative to large-caps.
In a small cap-led US equity space, the Russell 2000 Index has increased 10.3% relative to a 5.0% gain for the US large cap Russell 1000 Index so far this year. Meanwhile, the year-to-date volatility differential between small and large cap US stocks is at an all-time low, according to new research from Cboe Global Markets and FTSE Russell.
The iShares Russell 2000 ETF (NYSEArca: IWM), which tracks the benchmark Russell 2000 Index, has been outperforming this year. IWM gained 5.4% over the past month and is up 10.3% year-to-date. In comparison, the S&P 500 is up 2.8% over the past month and 4.9% higher so far this year.
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Cboe recently found that the “small cap premium,” or the difference between perceived US small cap volatility and US large cap volatility as reflected by average daily closing prices of the Cboe Russell 2000 Volatility Index (RVXSM) and the Cboe Volatility Index (VIX), is at the lowest point since it was first measured in 2004. The Cboe showed a 10% year-to-date differential for average daily closing prices through May between the RVX and VIX, compared to a high of over 50% back in 2006 and around 45% in 2017.
“The ‘small cap premium’ can be an effective way to measure investors’ perceptions of the volatility of US large cap stocks relative to US small cap stocks,” Russell Rhoads, CFA, director, product advancement, Cboe global markets, said in a note. “On average, small caps are historically more volatile than large caps, but this relative measure has been known to ebb and flow from year-to-year since we began measuring this important statistic in 2004. At 10.3% year-to-date, we are seeing a huge outlier for the ‘small cap premium’ and certainly a reflection of the market conditions we have seen so far this year.”
What’s Driving Small Cap Momentum
Observers have pointed to a number of reasons for the increasing momentum in the small-caps, compared to their larger peers. For instance, geopolitical risks, a stronger U.S. dollar and rising trade tensions have contributed to a murkier outlook for large multinational companies, whereas small-caps have benefited from deregulation and ongoing domestic growth.
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“With many of 2018’s equity headwinds being international in nature, the Russell 2000 Index has outperformed the Russell 1000 Index due in large part to small caps’ lower international sales exposure,” Alec Young – managing director, global markets research, FTSE Russell, said in a note. “Being more domestic has insulated small caps from trade tensions, geopolitical worries and the earnings drag stemming from a stronger dollar. Being less global also gives small caps more exposure to several positives within the US, including tax reform, increasing deregulation and faster economic growth relative to weaker recoveries in Europe and Japan. All these tailwinds are helping drive faster profit growth for small cap companies relative to their blue chip counterparts, helping fuel YTD leadership while tempering relative volatility for this asset class.”
For more information on small-capitalization stocks, visit our small-cap category.