The Small Caps/Russell 2000 Hot Streak Is About to Fade
- By John Tierney
- 1 min read
In early November, we argued that US small caps as expressed through the Russell 2000 index (RTY) should start to outperform. The index was still six points underwater compared with the start of 2020, while the S&P 500 (SPX) was up on the year. We thought, with the economy reopening and the prospect of vaccines on the horizon, small caps should perform well. Indeed, they have. The RTY index has surged 33% since then, far outperforming the SPX (+15.5%) and NASDAQ 100 (+18.2%). But going forward, if history is a guide, the RTY index will no longer outperform and will be much closer to a market performer.
Over the last 35 years, the RTY index has tracked the large-cap SPX index closely (Chart 1). It tends to underperform in recessions and big market selloffs, then recover sharply. After the initial rally, it tends to track or modestly outperform the SPX.
This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.
Summary
- The Russell 2000 index has been on a hot streak since the election, far outperforming the SPX and NASDAQ 100 indices.
- We expect it to be a market performer relative to the SPX index for now.
- It could rally further but not until more clear signs emerge of when the economy can fully reopen.
In early November, we argued that US small caps as expressed through the Russell 2000 index (RTY) should start to outperform. The index was still six points underwater compared with the start of 2020, while the S&P 500 (SPX) was up on the year. We thought, with the economy reopening and the prospect of vaccines on the horizon, small caps should perform well. Indeed, they have. The RTY index has surged 33% since then, far outperforming the SPX (+15.5%) and NASDAQ 100 (+18.2%). But going forward, if history is a guide, the RTY index will no longer outperform and will be much closer to a market performer.
Over the last 35 years, the RTY index has tracked the large-cap SPX index closely (Chart 1). It tends to underperform in recessions and big market selloffs, then recover sharply. After the initial rally, it tends to track or modestly outperform the SPX.
Delving deeper into the two indices’ relative performance after major selloffs, we averaged the relative returns after eight major selloffs since October 1987. We see the RTY tends to rally strongly for about six months before plateauing and then only modestly outperforming (Chart 2). Of course, each recovery differs, but most follow this pattern to varying degrees.
The relative performance since the March 2020 trough has been quite different. After meandering for six months, the RTY index rocketed higher, outperforming the SPX following the election. A combination of the Biden victory, further fiscal stimulus, and the vaccine drove the rally.
At this point in the cycle, we are scaling back our expectations for the RTY index. We expect it to be a market performer relative to the SPX. We don’t expect the RTY to outperform significantly until the vaccine is widely distributed and there are clear signs that the economy will fully reopen.
Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)