Study: why small cap stocks will probably continue to outperform large cap stocks


Small cap stocks are absolutely on fire this year. Here’s the Russell 2000 Index.

Meanwhile large caps are underperforming.

The Russell 2000 has gone up 7 weeks in a row. I demonstrated that this is a medium-long term bullish sign for the stock market (S&P 500) in yesterday’s market study.

Zachary in the Facebook Group asked a good question:

Have you also examined the Russell 2000 performance in such a scenario? I.e., Does the Russell typically outperform the S&P 500 over 6-12 months when it has gone up 7 weeks in a row?

That’s exactly what we’re going to look at today. When the Russell goes up 7 weeks in a row:

  1. What does the S&P 500 do in the next 6-12 months? (we’ve already answered this question – the S&P goes up every single time).
  2. What does the Russell 2000 do in the next 6-12 months compared  to the S&P? (Russell is small cap)
  3. What does the Dow Jones do in the next 6- 12 months compared to small caps? (Dow is large cap)

In other words, which index is most likely to outperform and which index is most likely to underperform? The Dow, S&P, or Russell?
Here’s what happens next to the Russell 2000 when it goes up 7 weeks in a row.

As you can see, the Russell 2000 has a tendency to outperform the S&P 500 on every single time frame. The Russell’s median returns are higher than that of the S&P’s. Remember: strength begets more strength.
Here’s what happens next to the Dow Jones when it goes up 7 weeks in a row.

As you can see, the Dow Jones underperforms the Russell 2000 on every single time frame. The Russell’s median returns are higher than that of the Dow’s.

Conclusion

Small cap stocks have outperformed large cap stocks year-to-date. When this happens, small cap stocks will most likely continue to outperform large cap stocks throughout the next 12 months.
This study is purely technical, but we can also understand why small cap stocks are outperforming from a fundamental perspective. Trump is clearly playing hardball on the trade front. Trade skirmishes hurt large cap companies more than small cap companies.

  1. Large cap companies derive more of their revenues and earnings from international sources.
  2. Small cap companies derive less of their revenues and earnings from international sources.

So in the event of a trade dispute, large cap companies will be hurt more badly than small cap stocks. The U.S.-China trade skirmish will probably continue for a few more months, which means that small caps will probably continue to outperform large caps in the near future.
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