The Stealth Bull Market for Small-Caps Rolls On

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3Q16 was a strong quarter for small-cap stocks. The Russell 2000 Index (+9.0%) was ahead of both the large-cap S&P 500 (+3.9%) and Russell 1000 (+4.0%) Indexes. Small-cap strength broadened in 3Q16, and 10 of 11 sectors posted positive returns YTD.

History Suggests the Small-Cap Rally Has Room to Run

Small-cap rallies typically extend beyond the Russell 2000's 32.6% increase from its most recent trough on 2/11/16 through 9/30/16. (And at the end of 3Q16, small-caps were just shy of their 6/23/15 peak).

There have been 12 declines of 15% or more for the Russell 2000 since its inception in 1979. The median return for the subsequent recovery period was 98.8%.

Far Short of the Median

Small-Cap Up Market Performance After a Decline of 15% or Greater Since Russell 2000 Inception (%)

¹ Median includes only full recovery periods
² Interim trough through current

Additionally, there is pervasive pessimism about the outlook for stocks. We've seen persistent outflows from equity funds and heard increasing notes of caution from investors. These are not the signals we would typically expect at or near a performance peak.

Outlook: As contrarians, we think we are still some distance from the next small-cap peak. The U.S. economy continues to muddle through with key pockets of solid growth including housing and employment.

To be sure, this comes with the caveat that global risks remain very real, with more than the usual amount of uncertainty, and a correction would not be surprising.

Small-Cap Growth Wins the Quarter, Value Leads YTD

The Russell 2000 Growth Index nosed ahead of the Russell 2000 Value this quarter, but value stocks had strong absolute results and still led year-to-date.

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