As major broad stock market indexes continue to struggle for upward momentum and whispers of a bear market become louder, small-cap stocks are quietly reaching new highs. That’s not just good news for small-cap investors, it’s also good news for the rest of the market, as president of NYSE trading firm Empire Executions Peter Costa told CNBC last Thursday, “You’ll never see a bear market start with the Russell 2000 hitting an all-time high.”
As of the close of trading Monday, the S&P 500 is up just 2.2% year to date. Meanwhile, the small cap Russell 2000 index is already up 6.6%, closing at 1,637.44 on Monday after reaching an all-time high of 1,639.04 earlier in the day. B. Riley FBR’s Art Hogan predicts the small-cap index will reach 1,800 by the end of the year, an approximately 16% rise from where it started this year and a further 10% climb from Monday’s close, according to a separate article by CNBC.
Small Cap Strength
Hogan argued that small caps are in a much better position to withstand a stronger dollar as the smaller companies of the Russell 2000 only do about 23% of their business overseas, compared to 47% of revenue coming from overseas for S&P 500 companies. Being less exposed overseas, these smaller companies will also be less affected by any fallout from potentially disruptive trade policies from the Trump administration.
He also mentioned that this group generally receives more direct benefits from lower effective tax rates, which were put in place at the end of last year. Hogan noted that, “We’re in early innings of this run,” and “This is a trade that’s got legs.” (See also: Small Caps in Russell 2000 Break Out to Fresh Highs).
The Bear Market Held at Bay
Despite the lackluster performance of the broader market this year, the strength in small caps is a good sign as highlighted by Costa’s remarks about a bear market never starting with the Russell 2000 hitting record highs, emphasizing that, “It’s never happened. It will never happen.”
Costa also indicated that he believes a compromise will be reached on trade talks, as policy leaders will come to their senses and realize that nobody ever wins a trade war. If a trade war is avoided then larger-cap companies that depend more on overseas revenue will be able to breathe easier and get back to focusing on their core business rather than worrying about what the future trade environment will look like. (See also: U.S. Tech Firms’ $150B China Revenue At Risk in Trade War).
Another nail in the coffin for the bear-market hypothesis is the recent reversal of the trend in the yield curve. While the year started with worries over the curve flattening, the month of May has so far seen that trend reversing with the yield curve getting steeper. John Burke, owner and manager of Burke Financial, told CNBC that, “The stock market has never come to a halt when the yield curve is getting steeper.”