As of yesterday’s market close, the Russell 2000 Index, a broad and widely followed gauge of small capitalization stocks, has gained more than 1% daily for the past five consecutive days. Let us put such impressive streak into historical perspective:
- Streaks of 4 consecutive days of greater than 1% daily returns have occurred only 14 times in the history of the Russell 2000 index going back to 1979. This happened on Monday.
- Streaks of 5 consecutive days of greater than 1% daily returns have occurred only 5 times in the history of the Russell 2000 index going back to 1979. This happened yesterday.
- Streaks of 6 consecutive days of greater than 1% daily returns have occurred only 2 times in the history of the Russell 2000 index going back to 1979. This may or may not happen today.
These occurrences are shown as the colored bars on the chart below. Please note that some bars overlap, as each 6-day streak was also a 5-day streak, and each 5-day streak was also a 4-day streak.
Source: CWA, Bloomberg, as of 7/16/2024
After such an unusual surge in small caps, is it time to take profits? History suggests otherwise. While the sample size is rather small, these occurrences have usually been followed by further strong gains over the next 6 to 12 months. For instance, after 5 consecutive days of 1%+ daily returns, small cap gains over the following 6 and 12 months are about twice their historical average. Of course, a pullback could happen at any time, but the evidence indicates that once small caps catch fire, it’s hard to put it out.
Source: CWA, Bloomberg, as of 7/16/2024
From a longer-term perspective, small caps remain deeply undervalued compared to large caps, as shown by their relative price-to-forward-sales ratio below. This further suggests small caps could have a lot more room to run. Of course, such undervaluation has been there for quite a while. However, we now have several catalysts that could finally spark a rerating: from the promise of Fed rate cuts as soon as September, to the expected broadening of earnings growth from mega-cap Tech to the rest of the market, to the prospect of deregulation. The past few days have provided us with a taste of what could be in store for small caps as these possibilities come closer and closer to being realities.
Source: CWA, Bloomberg, as of 7/16/2024
Sauro Locatelli CFA, FRM®, SCR®
Director of Quantitative Research
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