The Market Rollercoaster
Following an early August selloff, small-cap stocks diverged from the upward surge experienced by large caps, hinting at a cooling trend in market rotation that emerged in July.
The Russell 2000 index, closely monitored through the iShares Russell 2000 ETF Trust, encountered a notable decline at the beginning of August, with critical support at its 200-day moving average.
However, since then, the index has grappled with breaking above its 50-day moving average, indicating subdued investor optimism.
Surprisingly, on a recent Wednesday, the Russell 2000 reacted negatively to below-expectation July inflation figures, dropping by 0.7% and falling behind its large-cap counterparts.
This bearish response presents a stark contrast to the July small-cap rally triggered by a favorable June inflation report released earlier in the month.
The Bear Growls at the 50-Day Moving Average
Valuation Dilemma: Small Caps Unveiled
Analyst Jill Carey Hall from Bank of America underscored that the Russell 2000 is currently trading at a price-to-earnings ratio of 15.5x, marginally surpassing its historical average P/E of 15.2x.
Despite this, Hall expressed that “small caps remain cheap versus large caps,” trading at a roughly 25% discount to their historical average (relative P/E of 0.74 compared to the historic 1.0x).
Michael A. Gayed, CFA, a portfolio manager at Toroso Investments, shared insights into recent market dynamics, highlighting the rapid shifts in sentiment.
Initially, the rotation was ignited by a lower-than-anticipated U.S. inflation reading, combined with positive growth projections, fueling equity market rallies.
However, as concerns surfaced over recession risks following the disappointing July jobs report, the market’s appetite for risk diminished, causing small caps to lag behind their large-cap counterparts once more.
“If small-caps continue to trail in this manner, echoing the trend since late July, it signals a significant risk-off sentiment and intimates that the ongoing equity rebound could be illusory,” Gayed commented.
Exploring the Small Cap Frontier
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