While small-cap stocks (Russell 2000) were showing relative strength throughout much of 2018, their recent weakness in both September and October has led to underperformance versus the S&P 500.
Table 1 looks at major index total returns for September, October, the year to date through Oct. 5, as well as the three-year annualized change for each index.
TABLE 1: COMPARISON OF RECENT/THREE-YEAR MAJOR INDEX RETURNS
Source: Market data
The Russell 2000 was trading at oversold levels as of Oct. 5 (see Figure 1).
FIGURE 1: SMALL-CAP RUSSELL 2000 (1-YEAR TREND)
Source: Bespoke Investment Group
Bespoke Investment Group noted the performance discrepancy between large and small caps last Friday (Oct. 5):
FIGURE 2: S&P 500 DECILE PERFORMANCE BY MARKET CAP (OCTOBER 2018)
Source: Bespoke Investment Group
One school of thought holds that rising interest rates adversely impact small-cap stocks because smaller companies are usually more dependent on shorter-term financing and adjustable-rate loans than large caps. Further, the argument goes, the larger dividends generally paid by large-cap companies enhance returns on a relative basis versus small caps—an important factor when bond yields improve.
There is a counterargument, says Investopedia, that should benefit small caps in a rising-rate environment. In a 2016 article quoting Sam Stovall, U.S. equity strategist for S&P Global Market Intelligence, they wrote,
An August 2018 article in Seeking Alpha made the quantitative case that returns for small-cap stocks do not necessarily suffer during rising-rate environments—in fact, they outperform. Francis Gannon, Co-CIO at Royce & Associates, wrote,
FIGURE 3: SMALL CAPS VERSUS LARGE CAPS IN RISING-RATE ENVIRONMENTS (1998–2018)
Source: Seeking Alpha, “What Rising Rates Mean for Small-Cap Stocks,” August 2, 2018.
On a broader basis, when should investors start to worry that higher interest rates will have a significant impact on their overall stock holdings?
An April 2018 article from U.S. News and World Report offered a positive equity perspective for the current interest-rate environment and suggests there is a long way to go before rate increases become an issue for stocks—but suggests caution as well when relying on historical trends:
The opinions expressed in this article are those of the author and do not necessarily represent the views of Proactive Advisor Magazine. These opinions are presented for educational purposes only.
Oscar Alvarez, CFP, CCPS • Newport News, VA Pathway Financial Planning • Pathway Financial Planning Inc. Read full biography below Proactive Advisor Magazine: Oscar, please talk about your path to becoming a financial advisor.I grew up in San Antonio in a close-knit...
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