The performance disparity is somewhat unusual given that small-caps tend to lead in a bull market. But as I wrote in mid-November, small-caps have likely trailed this year since they got ahead of themselves in 2013.
That year they rose by 36% as compared to a 26.4% rise in the S&P 500. That rally led the S&P 600 Small Cap Index to trade with a forward PE of over 19. That’s a little rich. In my opinion, this was the catalyst for the lackluster performance in 2014.
The case against small-caps gained followers when the Russell 2000 Small Cap Index completed a “death cross” formation in mid-September. This event occurs when the index’s 50-day moving average (DMA) crosses below its 200 DMA.
At that time I wrote not to fear the death cross, and that investors should actually view the event as a buying signal. That’s because 30 years of data show that investors would have made money buying into the death cross 69% of the time. And if they held small-caps for six months they would turn an average gain of 13.6%.
It’s been just over two months and the Russell is up nearly 7%. So far, so good.
Heading into the final stretch of 2015 the conversation around small-caps has changed. It’s not about death crosses and historical relative performance. It’s much more about the potential for the asset class to deliver a healthy gain to investors over the next year.
And I still think there is significant potential. We just need two things to happen.
By the way, when considering how to play small-caps as an asset class, I like to point investors to ETFs. And in particular, I like ETFs that track the S&P 600 Small Cap Index. You can find options through both Vanguard and iShares.
The S&P 600 has outperformed the Russell 2000 by 1.8% annually between 1994 and 2013. Over a 20-year period that outperformance leads to $17,654 more in capital gains. So there’s really no argument in my view.