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Where Could Investors Profit When the Economy Fully Opens?

Is the Post-Pandemic Recovery Move into Small-Cap Stocks?

The Russell 1000 Index, a subset of the Russell 3000 Index, represents the top 1000 companies by market capitalization in the United States. The public companies within the measure add about 92% of the total  market capitalization of the full 3000 largest corporations. The market cap of the Russell 2000 or the remaining small-cap companies is approximately 8%. The Russell 1000 large-cap index is not quoted as often as the S&P 500; however, the Russell 2000 is usually the favored benchmark when referring to small-cap stock performance.

Despite the S&P 500 garnering much of the media attention, in 2020 the Russell 1000 exceeded the more widely quoted large-cap index’s performance. The S&P only returned 16% while the Russell 1000 returned 21%, or 5% more to investors. After the pandemic-altered economy, large-cap stocks received most of the attention, seeming to rise almost daily beginning in late March.  But small-cap stocks also had fantastic performance in the final measure of the up, down, then up again year. With a 20% return, they only trailed the high performing Russell 1000 large-caps by 1%.  A large portion of this performance was achieved beginning in early September. This trend may be important to watch as we look for follow-through buying in 2021.

The almost equal performances of the Russell 1000 and Russell 2000 in 2020 (up 21% and 20%, respectively) doesn’t tell the full story of the double-digit swings in leadership between the two indexes as the economic cards were being reshuffled in response to COVID-19.

Equity Market Returns Large vs. Small and Full Year Vs. Fourth Quarter 2020

US Small-Caps Experience Late Year Surge After Lagging Most of 2020

A weak correlation existed between large and small stocks. Much of the difference during late 2020 is attributed to the market sentiment regarding the post-pandemic outlook for a US recovery. These sentiment shifts are reflected in the chart below. It dissects both the Russell 2000 and Russell 1000 index’s full-year performance into five phases. Each seems to represent a pivot point and reaction to a revised outlook.

After significantly lagging behind its large-cap brethren during both the March run-for-cover sell-off and the summer invest-your-check lockdown rally, the Russell 2000 has been a leader since early September. The index rocketed in Q4, significantly eclipsing the Russell 1000. The reported change in sentiment came as positive signs in vaccine testing and generous monetary and fiscal support made headlines. The merger and acquisition activity spike toward the end of the year also helped smaller stocks, which are often M&A targets.

Five distinct phases of 2020 performance (% change)

Source: FTSE Russell. Data as of December 31, 2020. Past performance is no guarantee of future results.

Does the Russell 2000 Have a Cyclical Advantage?

The US small-cap rally may have also enjoyed a tailwind from the “broadening of overall risk” rally in Q4, away from the high-flying tech outperformers in the Russell 1000 and into the stocks viewed as more sensitive to the economic cycle. These include energy and financials, which are 18% of the small-cap index, compared to 12% in the large-cap. There is also a heavy weighting in the Russell 2000 toward Life Sciences and Healthcare. These sectors outperformed by approximately 5%.

The difference in composition is evident in the following chart of the top 10 industry contributors to each of the two indices’ 2020 performance.

Top 10 industry contributors to returns (% of total)

Source: FTSE Russell. Data as of December 31, 2020. Past performance is no guarantee of future results.

Take-Away

Since early September, the upward comparative performance of the Russell 2000 is largely a result of the ongoing rotation away from defensive plays into other sectors of the economy. The weakening US dollar may also play a part as U.S. goods become more competitive with overseas producers.

Though uncertainty is always the rule as far as investment markets are concerned, the late-year trend has remained intact during the first week of 2021 and is well worth keeping an eye on.

Sources:

Investopedia Russell 1000

FTSE Russell Financial Data

Yahoo Finance (S&P) Data

 

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