The Next Leg of the Small-cap Rally Starts Now
It’s set to be a banner year for the smallest stocks on the market.
This statement doesn’t sound so crazy today after the market has melted up to new highs.
But I received plenty of pushback when I first started talking about a continuation of the post-election small-cap rally at the very beginning of the year (Don’t worry – I won’t subject you to the nasty emails today).
Even market pros weren’t sure what to make of the situation. In early January, more than a few analysts and talking heads were worried about the sustainability of the small-cap rally. After an unbelievable double-digit run in November, the small-cap Russell 2000 had completely stalled out. For two months, small-caps remained trapped in a choppy range.
This prolonged consolidation concerned some folks. Had small-caps run too far, too fast? Were we due for a hard landing?
As with any powerful rally, small-caps needed to digest their big thrust higher. That’s not a bad thing. Of course, worrywarts complained—but we know that the resurgent bull just needed to blow off a little steam.
This week’s market action has put most doubts to rest. After nearly two years of pain, small stocks are exploding higher.
Every shred of evidence I have collected over the past few months has pointed to an extended surge in smaller stocks. Political, economic and market cycles are aligning perfectly in our favor.
Now it’s finally official. Yesterday was the fifth straight day of gains posted by the Russell 2000. More importantly, the small-cap index has broken out to new all-time highs. That’s right – small stocks have finally snapped out of their slumber.
Their path hasn’t been perfect. But after a pre-election pullback in October, small caps are finally back on top again. As of early December, the small-cap Russell 2000 had jumped 40% above its 2016 lows thanks in part to an incredible 14-day run. That was the index’s longest winning streak in more than 20 years.
This is how big changes in trend happen. One second, everyone hates small-caps. Just when the last seller leaves the building, a furious rally begins to take shape. And the powerful rally that sent the Russell to new highs late last year was only a preview of what’s bubbling up today.
We explained in early January why the sector was ripe for more gains. Data from Value Walk show the median return for the Russell 2000 following 15% declines is nearly 100%. The rally off the 2016 bottom has produced gains of about 45% so far. That means we have a long way to go to just reach an average recovery from the small-cap bear market.
Now that the Russell has blasted through to new highs, we’re going to see plenty of new investing opportunities in smaller stocks as the year progresses. No, small caps aren’t going to ramp higher in a straight line every single day. That ain’t how the market works…
Instead, we should look for improvements from some of the worst hit small-cap groups as the rising tide lifts all boats. We can also expect to see individual small-cap breakouts pop up that will give you plenty of chances at fast, double-digit gains.
One of the major hallmarks of the post-election bull is rotation. Different stocks and industries are breaking out every single week. As one group rests, fast money piles into the next hot trade. That gives us a phenomenal “stock picker’s market” – the perfect environment for booking short-term trading gains.