The Small-Cap Horse is Bucking, But Hold On

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By Lucas Downey, Contributing Editor, TradeSmith Daily


Markets keep chugging along, making new highs daily.

But as we all probably know by now, many stocks haven’t participated to the extent that large-caps have.

With the S&P 500 and NASDAQ both notching new all-time highs, the glaring question becomes “should we now look to under-loved small-caps as a value play?”

To help answer this question, we’ll do what we always do and turn to cold hard data for clues.

First, we’re going to revisit one of my favorite studies from late last year that said to buy small-caps hand over fist. Then, we’ll dive into a fresh new study that’s forecasting double-digit gains for the group in the remainder of the year.

We still see small-caps as one of the best plays for 2024.

And when you study the proof, you should too.

Small-Caps are Lagging, But for How Much Longer?

The S&P 500 gets all the glory lately. That glory is well earned, with it jumping 7.11% so far in 2024.

But small-caps have not participated at all, with the S&P Small Cap 600 (IJR ETF) falling 0.75% year-to-date.


On this basis alone, some may see small-caps as the better play going forward…

But let’s look back at where small-caps were just a few short months ago. Often, it helps to zoom out.

If you recall, back in October we made a very bold call to bet on small-caps. You may not remember just how unloved the group was back then.

With stocks in freefall, folks were more interested in buying “safer” Treasuries than anything else. The seductive, risk-free 5%+ yields were too much to resist.

But we broke from the pack to recommend buying small-caps on Oct. 19. And we did so because of something incredible that happened.

The forward P/E ratio for the S&P Small Cap 600 fell below 13.4.

In that writeup, we included a study that shows small-caps historically print double-digit gains a year after the P/E reaches those depths — going all the way back to 2003.

Fast forward to today, and the small-cap barometer has gained nearly 9% since Oct. 17. Below, we’ve included that powerful study, with updated values:


Clearly the 0.75% loss year-to-date for small-caps is a cooling-off period after the scorching rally that ignited back in October.

But if you think we’re gonna tell you to take profits… think again.

A negative performance for small caps in January and February is actually a powerful bullish omen.

Don’t Jump Off the Small-Cap Horse Just Yet

Sometimes you need to look backwards to see the future. After February came to a close, we did just that.

Back to 1995, the S&P Small Cap 600 has returned a negative cumulative performance in January and February 11 times.

Here’s what’s important.

On average after this happens, the remainder of the year boasts market beating returns of 14.65% vs. the 10.15% average for all years.

If you have any bearish buddies, give them a hug. This data suggests they’ll need it:


The bullish small-cap theme keeps showing up in the data. And if you’re looking for more ammo on what’s possible this year for the unloved area, feel free to revisit a fun piece from November titled, Save a bear (ride a small-cap).

There’s a renaissance in the works for so many smaller companies ripe for upside. A negative start for the first two months of the year is the next catalyst.

Don’t let the rodeo pass you by.

Regards,

Lucas Downey
Contributing Editor, TradeSmith Daily