USA (Washington Insider Magazine) – Once a year, smaller companies in the US stock market gain brief visibility during the annual changes to the Russell 2000 index of small-cap stocks. This event, known as the “Russell reconstitution,” occurs at the end of June and results in about a 50 percent increase in overall daily trading volumes for the US market. Despite this temporary surge, small-cap stocks continue to face challenges, underperforming large-cap indices and being overshadowed by mega-caps like Nvidia, which alone is valued as much as the entire Russell 2000.
Investor Reluctance to Shift Focus
Investors, particularly in Europe and the US, have shown little incentive to shift their focus from successful large-cap stocks to smaller companies. Steven DeSanctis, a US equity strategist at Jefferies, notes that investors prefer to stick with what is currently working rather than venture into smaller caps, which they are uncertain about. Conversations often revert to the performance of giants like Nvidia, further sidelining small-cap investments.
Arguments for Small-Cap Investments
According to Ft, Despite the lack of investor enthusiasm, some experts advocate for the benefits of small-cap stocks. Philip Greenblatt, portfolio manager and senior analyst at Easterly Investment Partners, emphasizes that small caps are excellent for diversification and are more liquid compared to alternative asset classes like hedge funds, private equity, and real estate. Additionally, smaller companies often provide better indicators of the real economy’s health, unlike larger corporations that benefit from broad trends such as the current demand for generative AI.
Importance of the Russell 2000
The Russell 2000 index, rather than the S&P 500, is frequently used by bankers as a benchmark for taking companies public, as it is the market gauge most new listings are likely to join. So far this year, the Russell 2000 has gained 1 percent, compared to the S&P 500’s 16 percent increase. The index’s constituents range from $10.7 billion FTAI Aviation, a jet engine maintainer, to $160 million Richardson Electronics, a specialty equipment distributor.
Small-Cap Underperformance and Future Prospects
Comparing the Russell 2000 and the S&P 500 over six months reveals that small caps have only underperformed their larger counterparts this significantly at two other points since the 2000 dotcom boom. Historically, however, returns from large and small caps are more aligned over the long term. Peter Kraus, founder of Aperture Investors, suggests that certainty about the timing and scope of interest rate cuts from the Federal Reserve could entice investors towards small caps. Analysts forecast a pickup in small-cap earnings later this year and into 2025 as the economic outlook becomes clearer.
Potential for Small-Cap Growth
As the second-quarter earnings season approaches, there may be a shift in investor sentiment. Even if small caps do not show the expected improvement, profit growth is projected to slow for many mega-cap companies. DeSanctis points out that investors will have choices if earnings growth broadens, allowing them to find other companies with double-digit earnings growth trading at lower prices. A significant uptick in the Russell 2000 could indicate a change in investor thinking and increased interest in smaller companies.