Small-cap woes highlight stock market’s dependency on mega-cap names

Small-cap woes highlight stock market’s dependency on mega-cap names

The Russell small cap index lost 0.1% Thursday.

Small-capitalization stocks missed out on a broad stock-market rally Thursday, acting as a fly in the ointment during the first full day of trade in 2020, when equities otherwise stormed out of the gate.

The small-cap Russell 2000 index RUT, -0.78% fell 1.7 points, or 0.1% to 1,666.7 on Thursday, versus a 1.2% advance for the Dow Jones Industrial Average DJIA, -0.89% , a 0.8% gain for the S&P 500 index SPX, -0.81% and a 1.3% rise for the Nasdaq Composite index COMP, -0.91% . The Russell underperformed the large-cap S&P 500 index by the largest margin since Nov. 11 of last year, according to FactSet.

Alec Young, managing director of global markets research at FTSE Russell said that the divergence between small and large-cap stocks Thursday was “a bit of a head-scratcher, especially because financial stocks have a big weighting in the Russell,’ and that sector held up well Thursday.

He said the phenomenon likely reflects investors’ eagerness to bet on the mega-cap momentum stocks like Facebook Inc. FB, -0.62%, Apple Inc. AAPL, -0.77% , Inc. AMZN, -1.45% Google parent Alphabet Inc. GOOG, -0.42% , and Microsoft Corp. MSFT, -0.84% all of which rose more than 1.9% Thursday, with investors pulling money from small-cap stocks to make those bets.

Meanwhile, Novocure Ltd. NVCR, -1.93%, one of the Russell’s largest constituents, fell 8.8% Thursday after Evercore ICI downgraded the stock.

“It is clear that the market’s idea of investing in 2020 is for all dollars to flow into the same five names,” wrote Mike O’Rourke, chief market strategist at JonesTrading, in a Thursday note to clients. “S&P 500 companies added $257 Billion in market capitalization [Thursday]. Apple, Amazon, Microsoft, Google and Facebook’s gains accounted for 43%, or $110 billion, of the market cap growth. Even more remarkable is that the average P/E for those 5 companies is 39.5x trailing earnings.”

“The behavior is starting to be very reminiscent of 1999 when ridiculous multiples were applied to the mega-cap companies of the day,” he added, pointing out that these five companies now compose 18% of the S&P 500’s market capitalization, while the two largest companies — Apple and Microsoft — are now $107 billion larger than the entire Russell 2000.

Steven DeSanctis, small-and-mid-cap equity strategist at Jefferies, forecasts small-cap stocks to outperform large caps in 2020, but likened the Russel’s under performance in the first session of the year to bad start to a baseball game. “You’re down 80 basis points to start the year, it’s like giving up a few runs in the first inning,” he said. “It’s a long game, but it’s not what you want to see.”

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