Investor Essentials Daily

Going into earnings season, the S&P 500 isn’t the index to follow

October 18, 2021

The last few weeks have been choppy for large-cap stocks. Investors have been set up for disappointment this earnings season, leading to short-term volatility.

This has already meant the S&P 500 Index is down around 1% over the past month, with the Nasdaq down 2% as well. The slowing of earnings growth for the near future, fears over inflation, and concerns with Washington’s threatening deadlock all point to a tumultuous quarter.

However, there is another part of the market which may not see the same type of volatility these next few months.

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The Russell 2000, the index of small and microcap names, is actually up more than 4% since Sept. 20.

Part of the reason for this is that the Russell 2000 has been relatively stagnant since March, while the other indices have continued to rally. The S&P 500 was up more than 15% from March 1 to Sept. 1. The Nasdaq was up more than 13% in the same period, while the Russell didn’t budge 1%.

The reason for this slowdown was a shift in investor focus. With folks again concerned about the global pandemic since May and the emergence of the Delta variant, the world of “At-Home Revolution” names once again saw a huge boom.

These names, bringing essential services into the home, are predominantly the large tech companies. These companies also sit on top of the Nasdaq and the S&P 500, driving these indices and inflating valuations.

Meanwhile, the small-cap and microcap names didn’t benefit the same way from at-home tailwinds. These smaller companies have been off people’s radars. During the second wave of the pandemic, folks were more focused on Amazon (AMZN), Alphabet (GOOGL), and Zoom (ZM), names that clearly benefited.

As the world starts to reopen again and these larger names come under pressure to deliver stellar results, the Russell 2000 can get the market’s attention once again as investors recognize the value of these “off the beaten track” names.

For context, these are the companies that took off between October 2020 and March 2021.

As investors realized these smaller names weren’t, in fact, about to go under and had great tailwinds from cheap lending and raised economic spending, they were trading at bargain prices.

From late October 2020 to March 1, the S&P 500 and the Nasdaq were only up 12% and 15%, respectively. However, the Russell 2000 was up almost 50% during the same period.

As some technical analysts at Real Money and other outlets have highlighted, taking a look at the Russell 2000 shows the market is beginning to recognize the potential for another small-cap and microcap run. This is not just based on hype, but on fundamentals as well.

This means people who can get in front of this next rally in the Russell 2000, just like the one a year ago that lasted until March, are uniquely positioned to benefit in an otherwise tumultuous time for stocks.

This doesn’t mean a crash is imminent in the large-cap markets. However, it does mean, for the moment, that large-cap names like Apple (AAPL) and Facebook (FB) may not be the best place to park your money. Instead, investors looking to hedge against exuberance may want to look smaller.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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