Today we want to look at the historical out- and under-performance of the Russell 2000 US small cap stock index versus the NASDAQ Composite Index, perennially heavy with US technology sector exposure. Over the last 20 years, both have gone through periods of besting the other. The question now is “Which is the right place to be going into 2021?”
The following chart shows 100-trading day relative price performance for the Russell vs. the NASDAQ back to 2000. When the line is above the y-axis, the Russell has done better than the NASDAQ over the prior 100 days, and when it is below it has underperformed. The y-axis runs from -30 points to +50 points.
We see 3 points in the data:
#1: For most of the timeframe here (2002 – 2016), you could set the proverbial clock with this relationship. When the Russell underperformed the NASDAQ by 8-10 points or more (2002, 2003, 2007, 2014, 2016, 2017, 2019), you could rely on small caps to play catch up over the next 100 days.
Conversely, whenever you saw the Russell outrun the NASDAQ by 8-10 points over the prior 100 days (2006, 2008, 2010, 2011 – 2013, 2016, 2017) you could bank on Tech catching a bid relative to small caps and closing up the gap in the next 100 days
#2: There are only 2 instances where this pendulum-like relationship (+10 points/-10 points) has really broken apart since 2000:
- The bursting of the dot com bubble, where the Russell outperformed the NASDAQ by 37 points (noted in the graph above) in 2001 and +20 points in 2002.
- The 100 days ending May – July 2020 (also noted in the graph), when the Russell underperformed the NASDAQ by 25 points.
#3: Through last Friday, the Russell and NASDAQ are essentially even over the last 100 trading days (0.9 points in favor of the NASDAQ, but it was +2.1 points to small caps on Wednesday so we’re calling it even). The pendulum has swung once again, in other words, and small caps are catching up.
Now, you know our positive view on US small caps; this chart both supports that idea and also shows where it could be wrong.
On the plus side for small caps relative to Tech: they are coming off their worst underperformance in decades and can therefore continue to play catch up. In fairness, 2020 was a perfect (positive) storm for Big Tech and a negative one for small US companies so that canyon you see in the chart is entirely understandable. But as investors look for companies with earnings and balance sheet leverage to a recovery, small caps fit that bill. Based on that, the pendulum swing in favor of the Russell can continue.
On the cautious side of the coin, the sharp-eyed reader will look at that chart above and think “this pendulum you’re talking about has been much more erratic since about 2016”. And that is true: the mean trailing 100-day return for the Russell 2000 was 2.3 points lower than the NASDAQ from 2015 to 2019 and as noted 2020 was pretty much a disaster until September.
Bottom line to all this: we’re sticking with our recommendation to overweight small caps through year end because history says there’s still enough room for the asset class to make some further headway against Tech stocks (and therefore the S&P 500). We will worry more about US small caps if/when they get to +8-10 points ahead of the NASDAQ, if only because of the point above regarding the more sporadic mean reversion we’ve seen since 2016. Until then, we think the group can work.