Market Extra: Small-cap stocks outperform so far in 2023 as U.S. equities book second week of gains this year

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Small-cap stocks are outperforming large-cap U.S. equities this year, in an upbeat start to 2023 after suffering steep losses last year.

The Russell 2000 index, which tracks small-cap stocks in the U.S., was up 7.1% this year through Friday, according to FactSet data. That beats the 4.2% gain for the S&P 500, a gauge of large-cap stocks in the U.S., over the same period. 

“Typically you get these long cycles where small or large leads, and we’re just coming out of an 11-year period  where large beats small by a meaningful amount,” said Rayna Lesser Hannaway, a portfolio manager at Polen Capital who focuses on small-cap stocks, in a phone interview. 

“Small-cap just looks really attractive on a relative valuation basis,” she said. “Small-cap typically tends to lead in the second half of interest-rate tightening cycles.”

The Russell 2000
RUT,
+0.58%

has also outperformed the blue-chip index Dow Jones Industrial Average and technology-laden Nasdaq Composite this year through Friday. 

Small and mid-cap stocks “anticipated the bear market of 2022 back in 2021 as their valuation multiples plunged well ahead of the drop in the forward P/E of the S&P 500,” according to a Yardeni Research note Friday. 

Forward price-to-earnings ratios, or P/E, for small and mid-cap stocks “seem to have bottomed during the bear market and may now be pointing higher,” Yardeni said in the note. “They are certainly cheap” relative to large-cap stocks. 

A chart in his note highlights the valuation of the S&P Small Cap 600 index
SML,
+0.56%

relative to the S&P 500.


YARDENI RESEARCH NOTE DATED JAN. 13, 2023

Last year the Russell 2000 dropped 21.6%, with losses exceeding the S&P 500’s 19.4% drop, according to FactSet data. The S&P Small Cap 600 fell 17.4% in 2022.

“It’s important to be discerning,” said Lesser Hannaway. 

“In this past year, there’s been a lot of higher-quality, small growth companies that have both fiscal discipline and managerial experience” to continue to grow even in a “tough” environment, she said. “That’s been largely ignored by the market as these stocks experienced a really significant drawdown without a lot of focus on the individual company fundamentals.”

The U.S. stock market ended higher Friday as investors digested fourth-quarter earnings results from big banks.

The Dow Jones Industrial Average
DJIA,
+0.33%

closed 0.3% higher, while the S&P 500
SPX,
+0.40%

rose 0.4% and the Nasdaq Composite advanced 0.7%, according to FactSet data. All three major benchmarks booked back-to-back weekly gains.

As for small-cap stocks, the Russell 2000 and S&P Small Cap 600 each ended 0.6% higher Friday. Both indexes also rose for a second straight week this year, with the Russell 2000 scoring a weekly gain of 5.3% to outperform the S&P 500’s 2.7% weekly rise.

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