It was a less than stellar market day today, with most indexes falling again save for the Nasdaq and Emerging Markets. Like yesterday we saw a bigger pullback from Small Caps, but that could be driven by some reversion rather than any bigger issue.
As you can see in the chart below (which depicts the performance of the Russell 2000 against the S&P 500), Small Caps have rallied some compared to the S&P 500 since their lowest point, but continue to do so in fits and starts. This slow upward climb compared to Large Caps has done little to dent the historic performance gap between Large and Small stocks that has emerged over the last decade.
All of a sudden, over the last few days the brief time in the sun that Value and Small Cap stocks had to shine has ended for now. Below you can see the big drop-off in relative performance (compared to the total S&P 500) for Small Cap and Value stocks.
Does this indicate anything in the long term? Who knows. To me it illustrates how market predilections can change rapidly and even oscillate between very different types of stocks. Predicting the short term relationship between Large and Small stocks is a fool’s errand. What is getting professional investors and advisors excited is the long term opportunity for Small Cap stocks and Value stocks compared to the broader market. As you see below, the gap between Small / Value stocks and Large / Growth stocks has been widening for the greater part of a decade.
The reason that these moves excite investors is that there is robust research on the long term performance advantage of investing in Small Cap and Value stocks. Now, this certainly doesn’t mean that any one type of stock will perform better than another in the near term, but this research does help inform professional investors about what the next five to ten years could look like.
What does this mean for investors? Stay diversified and don’t put all your eggs in one (or two) equity styles. Because like Small Caps and Value stocks, Emerging Markets and International stocks have also seen massive differences in performance as compared to US Large Cap stocks.
Again, no one can know when or if these trends will reverse and performance will change, but the performance differentials between Emerging stocks, International stocks and the S&P 500 have continued to stretch, and at a certain point we will likely see these differentials narrow, benefiting investors in Emerging and International stocks. Predicting the timing of that is anyone’s guess, but I have confidence that it will happen… some time.
Stay safe and be well,