America’s small cap stocks are severely lagging their bigger peers as the earnings season goes on and as the technology rally gains steam. The Russell 2000 index, which tracks most small cap companies, has dropped by over 2% this year and is still in a bear market. On the other hand, the S&P 500 (SPX) index crossed the milestone of $5,000 for the first time on Thursday. It and the Nasdaq 100 index have jumped by 5% and 7% this year.
Why small caps are strugglingThere are three main reasons why the Russell 2000 index is severely lagging behind the performance of the S&P 500 and Nasdaq 100 index. The first one is that the latter two are made of big companies like Nvidia and Meta Platforms that have done well in the past few months.
Indeed, as shown below, the closely-watched Invesco S&P 500 Equal Weight ETF (RSP) has risen by less than 1% this year. The RSP ETF provides an equal weighting to all companies in the S&P 500 index, making a mega cap like Apple equal to a smaller one like Etsy.
Russell 2000 vs RSP ETF vs Nasdaq 100 vs S&P 500
Mega cap stocks have done well this year, with companies worth over $1 trillion jumping to 7 today. This is the main reason why the Russell 2000 index is languishing.
The other reason is that the role of quants and algorithms has become bigger in the market than they were before. In the past, stock prices were influenced by a company’s valuation. As I wrote earlier today, valuations no longer matter as much, since algorithms are influenced by price action. This explains why companies like Nvidia and Crowdstrike have achieved PE multiples of over 70.
Small-cap stocks don’t have the benefit of momentum even though they are relatively undervalued as they trade at a PE ratio of 15. The S&P 500 index has a PE multiple of 23 while the Nasdaq 100 index has a multiple of 26.
Finally, these small-cap companies don’t benefit from high-interest rates as their bigger peers because their balance sheets are not all that cash rich. Big companies like Apple, Meta Platforms, and Berkshire Hathaway are making millions of dollars by just depositing their cash in money market funds. Couple this with the fact that many Russel 2000 index companies such as Bitcoin miners and biotech are not yet profitable.
Outlook for the Russell 2000 index
The daily chart shows that the Russell 2000 index has moved sideways in the past few days. On the positive side, it has remained above the 50-day and 100-day Exponential Moving Averages (EMA). It is also nearing the important resistance point at $2,000, the highest swing on July 31st last year.
The Russel index has also formed a hammer pattern, which is a bullish sign. The Relative Strength Index (RSI) has moved above the neutral point. Therefore, the outlook for the index is bullish, with the next point to watch being at $2,070, its highest point in December.
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