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Chart of the Day / Why Small Cap Stocks Broke to New Record Highs in 2018

Why Small Cap Stocks Broke to New Record Highs in 2018

May 21, 2018

In May 2018, the Russell 2000 hit another all-time high.

In fact, it broke to a high of 1,627.77 at the time with some analysts arguing for 1,800 by year-end.

All as small cap stocks sharply outperformed their large cap counterparts.

Even the S&P 600 small cap index was sitting at record highs, too thanks to energy stocks that have gotten a big boost from a recent jump in oil prices, which analysts predicted could boost earnings forecasts for the sector.

“The strength in small-caps may be a signal that investors are becoming more confident in the economy recovery,” said Lance James, who manages about $3 billion in small-cap funds as a senior portfolio manager of U.S. equities at RBC Global Asset Management, as quoted by Market Watch “If we see a rotation into the cyclical sectors of the small-cap universe, that could signal more gains ahead.”

Analysts at B. Riley FBR even predicted the Russell 2000 could push to new highs with a target of 1,800 – a 16% jump from where 2018 began.

They also believed small cap stocks are far better positioned to weather a strong dollar, and recent controversial trade policies.

Other analysts believed that small caps could push higher because most derive a bulk of their revenue from insider the U.S., shielding them from the overseas’ headwinds many of the larger cap names have been dealing with.  Plus, small stocks are less impacted by a stronger dollar, which makes U.S. goods sold abroad more expensive.

“Small-cap stocks tend to be more U.S.-focused in terms of their geographic footprint and where they derive their revenue. As such, they are seen as insulated from all manner of international headwinds, including trade policy and other geopolitical tensions. Furthermore, they are not suffering from recent strength in the dollar, which typically emerges as a headwind for large-cap companies by eroding their overseas profits,” noted Market Watch.

Meanwhile, large cap stocks have failed to reach record highs because of recent trade tensions thanks to tensions over overseas issues, such as trade war concerns.

“When the economy is stronger than normal, small caps do better,” said Ryan Detrick, senior market strategist for LPL Financial, as quoted by Reuters. “With a good economy like we’ve seen happening this year, we fully expect this to keep playing out in the second half of the year.”

Besides the expanding U.S. economy, corporate tax cuts have played a part, too.  In the past, small caps were forced to pay higher tax rates than their bigger rivals, which meant that in many cases, they had more to gain from the tax cut plans.

It’s why small cap stocks rallied to all time highs in mid-2018, leaving many of the larger cap stocks in the dust.