Markets may have found new leadership in some of the smallest companies on Wall Street.
The small cap-focused Russell 2000 has rallied more than 8% since the beginning of the year, far outpacing the large cap S&P 500‘s 1% gain. High hopes for the incoming Biden administration and for further financial relief have boosted the small caps, a group seen as a closer read of the real economy.
“The number one reason small caps are rallying is President-elect Joe Biden. Mr. Biden has fashioned himself as President Main Street,” Boris Schlossberg, managing director of FX strategy at BK Asset Management, told CNBC’s “Trading Nation” on Tuesday.
Biden’s $1.9 trillion coronavirus relief package, which was unveiled last week, includes direct payments to consumers and $350 billion in aid for government at the state and local level. Biden is being sworn into office Wednesday.
“The market is going to believe that he is going to try to do everything in his power, both from a financial point of view and also from a regulatory point of view, too, to make things much easier for small caps as we go forward,” Schlossberg said.
Biden’s proposed $20 billion national vaccine program should also expedite the recovery. Schlossberg said the smaller companies that endured the pandemic will be stronger for it.
“You have amazing operational leverage on the small-cap size because those companies that survived now have a chance to really rebound with much leaner staff, and therefore much better profit margins,” he said. “The much-better trade is going to be long Russell, short Nasdaq going forward. That’s a trade that has not worked at all for the last four years but I think is going to work very well in 2021.”
However, small caps have a long way to go before catching up with large-cap tech stocks, according to TradingAnalysis.com founder Todd Gordon. The Russell 2000 has fallen to its lowest level relative to the Nasdaq since the tech bubble peak, which could mean the latest rally is a “dead-cat bounce,” he said in the same interview.
Whether a temporary surge or otherwise, Gordon is willing to bet on one area of the small-cap space.
“You’ve got to take more of a step back and not say small caps in general are going to outperform. I actually think we want to look at small caps and break it into value vs. growth,” Gordon said.
While the IWM Russell 2000 ETF rallied on Tuesday, those gains were driven by the growth stocks. The Dow Jones small-cap growth index climbed 1.6% on Tuesday compared with the 0.6% gain for the Dow Jones small-cap value index. Outperformance in small-cap growth over small-cap value stretches back to the March 2020 bottom, Gordon said.
“It’s not so much a rotation value to growth. It’s large-cap growth into small-cap growth. So the growth trade is still there. We’re just sliding down the market capitalization scales a little bit,” said Gordon.
