Small caps in the Russell 2000 have broken out from a 10-month base, which is a compelling buy opportunity, according to a report released over the weekend.
This breakout suggests the beginning of a powerful bull market in small and mid-caps, and potential outperformance over large and mega caps.
Equal-weight sector ETFs show strong uptrends in technology, industrials, healthcare, financials, and consumer discretionary sectors – which are the key sectors within the Russell 2000.
Small caps completed a major bullish reversal, erasing initial losses suffered after a hotter-than-expected Consumer Price Index report.
That, plus the index break-out from a 10-month-long base, represents a key development, as it implies that the broad market may now be ready to participate in the rally.
In the last few weeks, heavyweight technology stocks, which make up a large portion of the S&P 500 and Nasdaq 100, have contributed to the steady uptrends of the two indices. But the participation of the Russell 2000 was sorely lacking.
This looks about to change, with the potential for a powerful bull market in small and mid-caps, Seeking Alpha reported.
Small cap stocks are due a period of strength. They have underperformed for a while, but over time, they outperform large cap, and that relationship will be restored at some point in time, writes financial advisor Martin Tillier on the Nasdaq’s news site.
Given that advisors are fond of saying that small cap stocks are much riskier than the stock of larger companies, it usually surprises investors to find out that, over long periods, small cap funds outperform their large cap counterparts. When you think about it though, it does make sense. By “risky”, advisors mean volatile, and that cuts both ways. Yes, small cap stocks tend to lose more ground when the market is falling but they also gain more when it is rising. So, given that stocks go up over time, the gains in small cap over extended periods are generally larger, Tillier notes.
The Russell 2000 hasn’t rallied the same way the big three indexes have this year. What could change the fortunes for small caps? Penn Capital Management CIO Eric Green says one thing that will help is getting a better idea of when the Federal Reserve will start to cut rates. He also points to credit spreads being at their cycle lows, saying “the credit market is suggesting we can get a really nice rally in small-cap equities,” Green was quoted in Yahoo Finance.
Another potential catalyst is merger and acquisition activity. Green said that given valuations, “a large-cap company buying a small-cap company right now is very accretive.” He goes on to say that he expects that we are at the beginning of an “M&A boom” that could lead to some small-cap companies being purchased by either a large-cap company or private equity.
Wild cards impacting a potential microcap rally include uncertainty on when the Federal Reserve will cut interest rates, as well as a mixed bag of January inflation data. Read more.
