Sluggish Small Caps - 1/25/2024
Stuck in the mud
The S&P 500 is setting new all-time highs this morning, but one segment of the market has been notably absent from the rally over the last year: the small caps. Ever since the spring of 2022, the Russell 2000 has been rangebound between its pre-COVID highs and the 138.2% retracement from the 2020 decline.
The lack of participation has frustrated a lot of small cap bulls, especially since the small caps found their floor in June ‘22, months before the large cap indexes bottomed that October. On the other hand, there’s nothing bearish about what the small caps are doing. This isn’t a downtrend to be shorting - it’s just an extended consolidation that hasn’t yet chosen a direction.
Until we do get that resolution, the small caps will continue to show relative weakness. Compared to the S&P 500, the Russell 2000 is in a clear downtrend and just got rejected by overhead supply at the March 2020 lows.
There’s no reason to be overweight the small caps as long as the March 2020 lows are intact. The opportunity cost of not owning the large caps is just too big until we see clear and convincing evidence of a reversal in relative strength.
Not all small caps are created equal
Now, just because small caps as a whole are something we want to avoid doesn’t mean we have to ignore the space entirely. Not all small caps are created equal.
A big part of the reason the small caps lagged in 2023 and are behind in 2024 is simply sector exposure. Information Technology and Communication Services were the two best performing sectors in the S&P 500 index last year, and those happen to be the two largest underweights in the Russell 2000.