In June, the Russell 2000, an index that monitors 2,000 of the smallest publicly traded companies in the United States, posted substantial growth. Although the index reached a record high of over 2,300 points in 2021, as of June 26 it is at 1,838 points, which is approximately 25% lower than its peak.
Still, the index has shown a 6.5% increase since the start of the month. The reason behind this surge in the Russell 2000 is speculated to be the heightened optimism among investors regarding the future prospects of the U.S. economy. The June surge marks the index’s strongest performance since January, suggesting that investors perceive an improvement in the health of the U.S. economy.
During periods of unfavorable economic indicators, investors often seek refuge in large-cap stocks due to their relative safety. However, when the near-term economic outlook begins to brighten, investors become more willing to take on riskier investments, such as small-cap stocks included in the Russell 2000.
Small Caps and Consumer Sentiment
The willingness of investors to put money into the Russell 2000 might have a potential trickle-down effect on consumers. Over the past 18 months, consumers have been hesitant to engage in discretionary spending due to concerns about inflation, recession, and potential job losses.
If the investors supporting the Russell 2000 are correct and the fears of a recession are indeed diminishing, consumers may start feeling more confident about relaxing their cautious approach to discretionary spending. This shift in consumer behavior could result in increased economic activity for companies of all sizes, regardless of their inclusion in the Russell 2000.
Naturally, unforeseen events can disrupt the upward trajectory of the Russell, but at present, its upward movement could be seen as an indication that the economy may be in a better position than previously assumed by many individuals.
Meanwhile, the S&P 600 small-cap index has rebounded about 8% from its low in May, and is on pace to post its first winning month since January.
Small cap stocks tend to be a barometer of where the US economy is headed, since smaller companies generate most of their revenue from domestic customers. They are also linked to financial stocks. While those stocks have stabilized since the banking upheaval earlier this year, continued stability is necessary for a sustained market rally because healthy banks underline a strong economy.
Bargain Hunters Rejoice
The S&P 600 is trading at about 13.5 times its expected earnings, below its 10-year average of 15.89. By contrast, the S&P 500, which contains large caps, trades at multiples of 19, above its 10-year average of 17.61. This means small caps are cheap both historically and in comparison to their large cap counterparts.
Despite these optimistic indications, if a recession does hit, small caps could take another pounding. After pausing in June, the Fed has warned of two more potential rate hikes this year, which would tighten credit and make it more difficult for smaller companies to borrow growth capital.
“I don’t think we’ve hit the dip on those small-cap stocks,” said Anna Rathbun, chief investment officer at CBIZ Investment Advisory Services, speaking to CNN.
