The broader US equity market has been enjoying a rally, but it seems that shares of smaller companies are outpacing it.
This has drawn the attention of investors who are interested in investing in cheap value stocks and those who believe that an economic slowdown has already been priced in by the group.
Small caps rise
There was a 10.4% rise in the Russell 2000 in July, while the benchmark S&P 500 index recorded gains of 9.1% in the same month.
This is the biggest outperformance that the small cap index has seen in a month in terms of percentage points since February.
Small caps tend to be less profitable and oriented more domestically, while their debt load is also heavier as opposed to their bigger counterparts.
This means that they tend to be in the firing line when there is volatility in the markets and concerns about the economy rise.
This year has not been different in this regard because there has been a 16% drop in the Russell 2000 so far, even though it did rebound in July.
Meanwhile, the S&P 500 index has seen a drop of 13.3% in this year so far, as the aggressive tightening of the interest rate by the US Federal Reserve dampened risk appetite across markets.
Right now, the small-cap index has reached its cheapest value since March 2000, as opposed to the large-cap Russell 1000, which has caught the attention of investors looking for a bargain.
Market analysts said that the small-cap space had seen a great deal of damage and has now become the cheapest segment in all of the US market.
The prices of small caps are believed to be more attuned to the fluctuations in the economy. Therefore, some investors think that their prices may already reflect a potential recession.
This would mean that if the predictions do come to pass, the downside in small caps is going to be limited.
This week’s data showed that the gross domestic product (GDP) in the US fell for the second quarter in a row, which fulfills a definition used for recession.
But the official business cycles arbiter, the National Bureau of Economic Research, has not declared a recession as yet.
This week, the chairman of the Federal Reserve, Jerome Powell, also said that the economy was unlikely to see a recession, as the employment backdrop remained strong.
Market analysts said that small caps were already pricing in a great deal of pain and recessions are an excellent buying opportunity for such stocks.
It is also important to note that the forward price-to-earnings ratio of the Russell 2000 index is in the 11-13 times range, which indicates the bottom.
Regardless, not everyone believes the time is right to purchase small caps. If inflation does not back down, it is likely to sap the appetite of stocks of smaller US companies.
This would also be true if the US Fed continues to raise its interest rates just as aggressively as it is now.