The US Russell 2000 small cap index (RTY) has been leading the charge since late 2020, even on Friday when the Dow fell -180-points the RTY managed to eke out a respectable +1.3% gain. To put things in perspective this seldomly discussed index has outperformed the S&P500 in 2021 by a factor of 8x as optimism around Joe Biden and ongoing stimulus have fuelled this index which is often regarded as a close read of the real economy i.e. investors are bullish the US like ourselves through the year. The market believes President Biden will do everything in his power both from a financial and regulatory perspective to help smaller companies with his focus on stamping out COVID a great starting point – even if he fails the markets likely to run with this thematic for at least a year or so.
In simple terms small-caps have operational leverage to an economic recovery, just like MM has been advocating Value over Growth this year we believe the RTY will continue to outperform the S&P500. This is also another move further up the risk curve by investors who are effectively betting that small caps will recover and enjoy growth well above household names like Apple (AAPL US), McDonalds (MCD US) and Nike (NKE US). Similarly, we believe European equities, which have lagged US equities significantly, will bounce back as the impact of the vaccine sends a sigh of relief across Europe.
When we look at the comparison of the small cap Index and major S&P500 index it’s clear that the RTY has played some catch up of late but there’s still plenty of potential underperformance to address if the economy recovers and remains robust. However, by definition the risks increase on the stock level as opposed to the index level hence when shopping for a portfolio research must be done thoroughly and the risk / reward clearly defined e.g. the smallest 5 stocks in the ASX200 have declined by an average of almost 40% over the last year hence we are looking for smaller stocks that are improving not necessarily the “dogs” that may recover.
