Why Small-Cap Stocks Are Poised to Outpace Large-Caps

Two charts illustrate how and why the Russell 2000 is strengthening.

The first is a daily chart that compares the price action of the Russell 2000 to the S&P 500 since July 2018. The Russell 2000/S&P 500 ratio—derived by dividing the Russell 2000 by the S&P 500—is on the verge of hurdling a two-year downtrend and climbing from a seven-month base.

The second is a chart of the Russell 2000’s daily advance/decline line since September 2018. What stands out is the positive divergence between the Russell’s breadth and its price action. While the index declined more than 30% from 238 to 162, the advance/decline line registered a significantly higher bottom. In other words, the index was camouflaging that more stocks had begun to turn higher—even as the index itself declined.

Our Aug. 9 report to clients illustrated that 30-year T-Bond yields had bottomed at 1.25%—and have risen in anticipation of the Treasury’s growing financing needs and because of rising grain prices.

Since then, yields have climbed 40 basis points, though the 10-year T-Bond yield has risen just 28 basis points, from 0.56% to 0.84%. (A basis point is 1/100th of a percentage point.) This is important: Since 1990, whenever the Russell 2000 outperformed the S&P 500, the spread between the 30-year T-Bond yield and the 10-year T-Bond yield widened. And since February, the spread has widened by 30 basis points.

It is for these reasons that I expect small-caps to outperform large-caps in the weeks ahead.