What happens when small cap and NASDAQ diverge so much


2017 has seen a remarkable divergence between small cap U.S. stocks (Russell 2000 Index) and high flying tech stocks (NASDAQ Composite). The NASDAQ has outperformed the Russell 2000 by more than 15% year-to-date (237 trading days).
As a result, many investors are buying small cap stocks and selling tech stocks in anticipation of sector rotation. Are they right in doing so? Will the small cap index outperform the NASDAQ?
Here are the historical cases when the NASDAQ outperformed the Russell 2000 by more than 15% in 237 trading days.
*We’re excluding dates when there are a cluster of these signals.

  1. July 6, 1995
  2. July 29, 1997
  3. July 22, 1998
  4. June 4, 2003
  5. September 8, 2009
  6. September 22, 2014
  7. November 8, 2017 (present case).

My Medium-Long Term Model does not foresee a significant correction or bear market right now. Based on this historical study, will the NASDAQ outperform or will the Russell outperform in the next year?
Click here to download the data in Excel.

July 6, 1995

  1. RUT up 5%, NASDAQ up 5% 3 months later
  2. Rut up 8%, NASDAQ up 8% 6 months later
  3. Rut up 16%, NASDAQ up 17% 9 months later
  4. Rut up 20%, NASDAQ up 23% 1 year later

July 29, 1997

  1. RUT up 2%, NASDAQ down -2% 3 months later
  2. Rut up 4%, NASDAQ up 2% 6 months later
  3. Rut up 16%, NASDAQ up 17% 9 months later
  4. Rut up 3%, NASDAQ up 19% 1 year later

July 22, 1998

  1. RUT down -20%, NASDAQ down -16% 3 months later
  2. Rut down -6%, NASDAQ up 19% 6 months later
  3. Rut down 4%, NASDAQ up 30% 9 months later
  4. Rut up 0%, NASDAQ up 36% 1 year later

June 4, 2003

  1. RUT up 13%, NASDAQ up 13% 3 months later
  2. Rut up 22%, NASDAQ up 21% 6 months later
  3. Rut up 32%, NASDAQ up 25% 9 months later
  4. Rut up 24%, NASDAQ up 19% 1 year later

September 8, 2009

  1. RUT up 4%, NASDAQ up 7% 3 months later
  2. Rut up 17%, NASDAQ up 15% 6 months later
  3. Rut up 7%, NASDAQ up 5% 9 months later
  4. Rut up 10%, NASDAQ up 9% 1 year later

September 22, 2014

  1. RUT up 5%, NASDAQ up 5% 3 months later
  2. Rut up 11%, NASDAQ up 10% 6 months later
  3. Rut up 14%, NASDAQ up 13% 9 months later
  4. Rut up 1%, NASDAQ up 5% 1 year later

Conclusion

  1. On a 3 month basis, Russell outperforms 1 time and NASDAQ outperforms 2 times.
  2. On a 6 month basis, Russell outperforms 4 times and NASDQ outperforms 1 time.
  3. On a 9 month basis, Russell outperforms 3 times and NASDAQ outperforms 3 times.
  4. On a 1 year basis, Rut outperforms two times and NASDAQ outperforms 4 times.

As you can see, there is no clear outperformer. Sometimes small cap Russell outperforms, and sometimes tech NASDAQ outperforms. The conclusion that I draw from this is simple:

If you’re going to go long stocks, just buy the S&P 500’s ETF. Don’t buy a Russell 2000 ETF or a NASDAQ ETF. It’s impossible to consistently and accurately know which index will outperform and which index will underperform.

Some investors/traders argue that small cap will outperform tech due to the Republican tax cut. Perhaps they are right. But perhaps they are wrong. One can argue that tech companies will repatriate a lot of cash from overseas and buyback their own stocks. (Small cap companies don’t have a lot of tax stashed overseas, so repatriation won’t impact them as much).

6 comments add yours

  1. Hi Troy –
    Thanks for the post.
    Reviewing a prior post, I see you’re either 100% long or 100% cash. Related to your point of not knowing which cap-size will be a clear winner, what are your thoughts on buying exposure for the whole market via a total market fund or ETF vs. just the S&P 500 ETF?
    – Mike

    • I don’t have an opinion on that. I assume it would be similar, because the S&P does a pretty good job of reflecting the broad market.
      I chose the S&P 500 ETF because my model uses S&P data.

        • At this rate, it’ll take 7 months for the curve to invert. Then typically another 7 months until recession.
          *Right now, some of the big name hedge fund managers like David Tepper think the curve will steepen a little before flattening again.

Leave a Comment