Welcome back to the big dance, small-cap stocks.
After underperforming the Nasdaq Composite and S&P 500 for the majority of this year — and of course from the rally off the COVID-19 February panic lows — the Russell 2000 small-cap benchmark has quietly staged a strong rally this past month. As it stands the Russell 2000 is on track for its best month relative to the Nasdaq 100 since November 2016, according to Bloomberg data.
Over the past month, the Russell 2000 has surprisingly gained 11% — the S&P 500 and Nasdaq are up 5% and 2%, respectively. The move has caught a few folks on Wall Street flat-footed mainly as the COVID-19 pandemic continues to depress economic activity in the United States. And, an argument could be easily be made that macroeconomic data has worsened in recent weeks — suggesting a sustained rough road ahead for domestic-centric companies.
That said, strategists are beginning to warm up to beaten down small-caps in anticipation of a 2021 economic rebound.
“I think there is some real leverage there in the economy. So I think you’re seeing small caps do better,” Ned Davis Research chief U.S. strategist Ed Clissold told Yahoo Finance’s The First Trade. “There’s some room to go with small caps.”
But the valuation — and earnings projections — on the Russell 2000 hints that investors need to be convinced more of a strong U.S. recovery next year and the logic to play that by buying small-caps today.
The Russell 2000’s forward price-to-earnings multiple of 18.2 times in July was shy of the 18.6 times seen in June, per research from Bank of America Merrill Lynch.
“An upward revision cycle could make multiples more attractive, and we have seen a recent bottoming in revision trends across segments — but analysts are still making more cuts than raises to estimates within small caps, while the opposite is now true in large,” points out BofA’s Jill Carey Hall.