What Small-Cap Underperformance Tells Us

October 20, 2014

In small-stock underperformance, history tells us there's not much to worry about.

Consistent with the reputation of September and October as months that often see higher volatility, the onset of fall ushered in renewed financial-market turbulence.

Amid the pickup in volatility, much has been noted about the relatively wide performance difference between large-cap and small-cap stocks. For example, the Russell 1000 Index of large-cap stocks was up 6.5 percent year-to-date as of Oct. 2, while the Russell 2000 Index of small-cap stocks was down 4.8 percent for the period—a performance difference of 11.3 percentage points.

Similarly, the S&P 500 Index of large-cap stocks was up 6.9 percent while the S&P SmallCap 600 Index was down 4.2 percent—with a similar performance difference—11.1 percentage points.

This can be seen through the ETF lens by looking at the performance chart for the SPDR S&P 500 (SPY | A-97) and the iShares Russell 2000 (IWN | A-76):

IWM_Vs_SPY_YTD

Chart courtesy of StockCharts.com

This volatility has arisen despite continued signs of economic strengthening and solid corporate earnings. Economic growth stumbled early in the year, but it has strengthened as the year progressed. GDP increased at an annual rate of 4.6 percent in the second quarter, according to the Bureau of Economic Analysis. At the same time, unemployment has continued to decline, falling to 5.9 percent in September.

So what can we make of this performance gap between large-cap and small-cap stocks? How unusual is it and should it be raising red flags for investors?

While every expansion and market cycle is somewhat different, historical market behavior can shed some light on whether this recent performance gap is truly unique and cause for potential concern or perhaps not as uncommon as might be assumed.

 

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