Vaccine-driven rotation in November could hint at comeback over next 12 to 24 months
Since the stock-market low in March, large-cap tech companies benefiting from the stay-at-home economy have driven an advance in global markets. In November, markets rallied further on news of three major candidate vaccines against Sars-COV-2, the virus that causes COVID-19, with each announcement made on a separate day.
While those with broad equity-market exposure certainly have reason to celebrate, a look under the headlines suggests a significant small-cap rotation is afoot.
“Over those three days on average, the S&P 500 Index was up 0.97%, while the U.S. small cap index (as measured by the Russell 2000 Index) was up 2.64% or 2.7 times more,” said Anil Tahiliani, CFA, MBA, and vice president at Matco Financial.
The analysis focused on the Russell 2000 rather than the S&P/TSX Small Cap index, he said, because the latter has a heavy 40% weighting towards resource stocks. The longer history of the Russell 2000, in addition, enables an analysis of longer-term performance history.
Tahiliani said that over the period from November 1 to 27, the Russell 2000 advanced 21%, while the S&P 500 went up just 11%. That reflects a strengthening case for professional investors to rotate into small-cap companies, he said, as a recovery in the U.S. and Canadian economies would favour domestically exposed small caps.
“Small cap stocks are trading at lower valuations than large cap companies,” Tahiliani said, noting that smaller companies have room for earnings growth, higher valuations, and faster stock-price capital appreciation. And with small-cap stock returns trailing those for large caps, investors are starting to pare back on winners and snap up laggards.
Citing research from Citigroup, he said the Russell 2000 has returned 15% on average in the year following a U.S. presidential election since 1980 – around four percentage points better than large-cap stocks’ average returns.
Going back even further, he said small-cap stocks have had an 87% probability of outperforming large caps in the year following every U.S. equity bear market low since 1932. Looking over the two-year period following a bear market, the odds are still better than even at 67% in favour of small caps.
