Save a Bear (Ride a Small-Cap)

By TradeSmith Research Team

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The long and painful stock market drought is coming to an end…

After yesterday’s ice-cold inflation number, bullish drumbeats sounded across the market.

October’s Consumer Price Index (CPI) was flat month-over-month, but increased 3.2% from last year. Both of these measures came in well below Wall Street estimates.

This long-awaited inflation victory feeling drew out animal spirits from bruised investors. The beaten-down S&P 600 small-cap index surged 5.5% alongside a collapse in Treasury yields. That’s the biggest single-day move in over a year.

The 10-year yield dropped to 4.42%, essentially shutting the door on the higher-for-longer mantra.

Given the latest rip in small-cap stocks, the million-dollar question is: Where do they go from here?

Let’s just say you might want to give your bearish friend a big, comforting hug…

Last week I told you a rare bear-killer signal was flashing. This latest surge in small caps only reinforces that stance.

I am bullish on this market, as you should be — especially on small caps. And I’ll prove exactly why today.

Before we get into this informative study, let’s first review the market landscape.

A Stock Market Revival Is Here

Investors drew a line in the sand on Oct. 27. That’s the date of the recent equity trough.

Below you’ll see how ferocious the rally has been since then. In a dozen trading days, the S&P 500 has ramped 9.6%:

Source: Yahoo Finance

Not only have large-cap stocks ripped, but small-cap stocks have surged even further.

This makes sense. Small caps have been stuck in the penalty box as interest rates have surged over the last couple years. Higher loan costs are weighing on these capital-intensive companies.

But now, as yields have collapsed, these groups are set to surge faster than the broad market.

Below is a list of every major market sector and its performance since the bottom on Oct. 27. We can see the big winners are small caps, mid caps, discretionary, technology, real estate, and growth:

No doubt, the latest rally has stunned the crowd. Stocks relentlessly marching higher day after day could make you believe this rally is ready to retrace.

But as it turns out, this surge historically brings big forward returns with it…

What a 5%+ Rally in Small Caps Means Going Forward

Readers know I’ve been vocal about my bullish stance recently. Back on Nov. 2 I showed why you should always remember to buy in November, with plenty of evidence suggesting better days were coming for the market.

Anytime there’s a 5%-plus day in small caps, it falls into the “best days” category.

Going back to 2000, there’ve been 32 instances where the S&P Small Cap 600 was up at least 5%.

Warning: If you’re allergic to green, look away now.

A month later the group is up an average of 2.6%.

Six months later, you’re looking at 14.4% gains.

Now comes the cherry on top. One year later, small-cap stocks jump 44.1%:

These are the types of returns that only occur after extremely oversold conditions. My call to buy small caps last month details the rare setup then.

After this latest thrust, my stance has only gotten stronger.

If you’ve heeded the advice, picking away at oversold opportunities, congrats! The evidence points to even more gains ahead.

But if you’ve held off, don’t fear you’ve missed the boat. History shows there’s still plenty of money to be made in small-cap stocks over the next year.


Lucas Downey,
Contributing Editor, TradeSmith Daily