Leave Small-Cap Stocks For Dead
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[May 17, 2014]
By Rodrigo Campos
NEW YORK (Reuters) - There
are many reasons for the sharp underperformance of
small- cap stocks in the past six weeks, but the recent
correction may be winding down, which means investors
worried about a broader selloff might be able to breathe
The Russell 2000 <.RUT><.TOY> briefly dipped into correction
territory - down 10 percent from its March peak - two days after the
Dow Jones industrial average <.DJI> and the S&P 500 <.SPX> closed at
That divergence is uncommon. It has caused some to fear that a
strong selloff in large-cap stocks will follow, painting an
all-around dire picture for equities. Some investors don't see it
that way, though. They believe that improved economic growth and
rising merger-and-acquisition activity should halt the decline in
"Growth in small-cap business is still intact, and they will
continue to do well," said Gary Bradshaw, portfolio manager at
Hodges Capital Management in Dallas.
"Large-caps are flush with cash, and we think there's going to be a
lot of acquisitions out of small-caps."
The slide in small-cap companies' stocks might be more related to
valuation than any bigger signal on the economy or a sudden aversion
to equities. The small caps had an outstanding run in 2013 that made
them look vulnerable, and this past earnings period made that all
At the end of 2013, the difference between the forward
price-to-earnings ratio on the Russell 2000 and the S&P 500 was near
its highest going back to at least 1978, according to data from
Citi. The Russell's forward P/E ratio was 24 then and the S&P 500's
Now the Russell's forward P/E ratio is 21.5 and the S&P 500's is
15.3. That's still a substantial difference.
Looking at earnings, large caps have performed better. Just 25
percent of S&P 500 components have missed expectations for per-share
earnings in the first quarter.
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By comparison, a Thomson Reuters index of nearly 2,000 companies in
the small- and mid-cap space showed 44 percent have missed earnings
forecasts so far, according to StarMine data.
"The most pronounced divergence I am seeing this year relates to
quality and consistency of earnings," said Brad Lipsig, senior
portfolio manager at UBS Financial Services, speaking of small- and
Fear has been part of the equation as well. Investors have shied
away from hyper-growth companies since February as biotechnology and
Internet stocks slumped. That drove flows away from the iShares
Russell 2000 exchange-traded fund <IWM.P>, which in turn pressured
the underlying stocks.
But the tide may be changing. Weekly inflows into the IWM ETF in the
week ended Wednesday were the highest in dollar terms in four years,
according to Lipper data.
"If this does stabilize, we could see a turn, with small caps
holding up better," Steven DeSanctis, small-cap strategist at Bank
of America Merrill Lynch, told clients in a Friday note.
(Wall St Week Ahead runs every Friday. Questions or comments on this
column can be emailed to: rodrigo.campos(at)thomsonreuters.com )
(Reporting by Rodrigo Campos; Editing by Jan Paschal)
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