Will Small-Cap Resurgence Lead Stocks Higher?

Small-caps have bounced back off the mat in a big way — is this a sign of good things to come for the overall market?

One of the big developments in the stock market this past week has been the resurgence of the small-cap segment of the market. After lagging pretty much all year, small-caps have put on a historically blistering rally in recent days. This development has many market pundits talking about an impending fresh new leg higher in the stock market. But is that necessarily a sure-fire conclusion?

One of the historic ways the small-cap resurgence has manifested itself is in the group’s out-performance versus the large-cap S&P 500 (SPX). For example, from Monday through Wednesday of this week, the small-cap Russell 2000 (RUT) out-paced the S&P 500 by more than 1% on each day. That was just the 10th such streak that we found on record. Here are the prior dates overlaid on the SPX.

Here are the dates overlaid on the RUT.

From a glance at the charts, we can see that some of the prior occurrences did indeed precede sharp rallies (e.g., Octobers 1998 & 2014 and post-election 2016). However, the signal’s track record as a positive harbinger is hardly unblemished. That’s because we also observe occurrences in close proximity to the cyclical top in 2000 and the flash crash in 2010.

We don’t mean to throw cold water on the small-cap resurgence. It is certainly a welcomed development for bulls. However, we would caution that the signal is not necessarily a sure-fire all clear sign. Historically, if it is a consistent sign of anything, it is symptomatic of periods of elevated volatility.

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Disclaimer: JLFMI’s actual investment decisions are based on our proprietary models. The conclusions based on the study in this letter may or may not be consistent with JLFMI’s actual investment posture at any given time. Additionally, the commentary provided here is for informational purposes only and should not be taken as a recommendation to invest in any specific securities or according to any specific methodologies. Proper due diligence should be performed before investing in any investment vehicle. There is a risk of loss involved in all investments.