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TPA Analytics: The 2-Month Small-Cap Rally Is Deceiving

By Jeffrey Marcus | May 26, 2020
Small-Cap, TPA Analytics: The 2-Month Small-Cap Rally Is Deceiving

Be careful. The 2-month small-cap rally is deceiving as it is tied to healthcare and COVID-19.

Is the rally broadening out? Are Small Cap stock stocks finally going to get their due after being thrown aside for so long for a narrow group of large cap growth stocks? If the answer to this question is “yes”, it would be easier to feel more comfortable with the recent huge rally, since a broad based rally is always a healthier rally than a narrow rally based on a small subset of stocks. Technical analysis likes to see “participation” or a lot of stocks getting involved to believe that a rally is sustainable.

The pattern has improved for small cap stocks. The first relative performance chart below shows that on a 2020 YTD (year to date) basis, the Russell 2000 trails to S&P500 by a wide margin; Russell 2000 down 18.76% and the S&P500 down 8.53%. Since the 3/23/20 low, however, the relative performance of the Russell 2000 has been much improved. The Russell 2000 Index is up 35.22% since the March low, while the market benchmark S&P500 is up 32.09%. It would seem that small cap stocks are finally being recognized and that investors can feel comfortable that the rally has broadened out to include more stocks.

Small-Cap, TPA Analytics: The 2-Month Small-Cap Rally Is Deceiving

Digging Into Small-Cap Rally

If one digs deeper, however, there is also a narrow rally in small cap stocks driven by the specifics of the Pandemic.

Chart 2 shows that small cap growth is the best performer since 3/23; up 41.60%, while small cap value is the worst performer of all the broad market categories; up only 27.47%.

If clients look at the period performance table below, they will see each broad market category ranked by performance for 2019, 1 year, 2020 YTD, and since the 3/23 low. The chart that follows shows the rank change over these periods. One can see the Russell 2000 growth index moving up 2 rankings, while both the large and small cap value indexes are unchanged and in last place. What happened since 3/23 as small cap growth did so well, while small cap value underperformed? TPA would point to the group weightings for the answer.

The table below shows the top industry groups in the Russell 2000 Growth Index. The second table highlights the Healthcare related weightings in the index. The groups Biotech, Pharma, and Healthcare make up a third (32.79%) of the small cap growth index. Healthcare has been the main focus because of Covid-19.

Small-Cap, TPA Analytics: The 2-Month Small-Cap Rally Is Deceiving

Small Cap Rally Breakdown

32% of the Russell 2000 Growth index is biotech, pharma, and healthcare.

Finally, the table below looks at the performance of the constituents of the Russell 2000 since 3/23. The Healthcare related parts of the small cap index were up 49.23%, on average. This far outperforms the Russell 2000 (+35.23%0 and the S&P500 (+32.09%) and even crushes the performance of the small cap growth index, which was up 41.60% in the same timeframe.

After diving deep into the reasons for the Russell 2000 outperformance, it is plain that small cap outperformance was due to the return of small cap growth and certainly not small cap value, which was a huge underperformer. Also, the outperformance of small cap growth was actually due to one group; Healthcare. The next table shows that the top 2 groups in small cap value are Banks and REITs, which badly underperformed, up only 20.64% and 7.62%, respectively, off of the March low.

Small cap’s rally may broaden out, but the outperformance of small cap since the 3/23 was due to small cap growth and, more particularly, small cap Healthcare and Covid-19. If clients are going to look for small cap stocks to own, they will still need to focus their attention on certain well-performing groups.

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Jeff Marcus founded Turning Point Analytics (TPA) in 2009 after 25 years on trading desks and 13 years as a head trader to provide strategic and technical research to institutional clients. Turning Point Analytics (TPA) provides a unique strategy that works as an overlay to clients’ good fundamental analysis. After 10 years of serving only large institutions, TPA now offers its research services to mid and small managers, RIA’s, and wealthy sophisticated individuals looking for a way to increase their returns and outperform their peers.

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