History Repeats Itself; Small-Cap Markets on a Tear, Surpassing Blue-Chip Performance

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In recent months, U.S. markets have rallied amid incessant quarreling in Washington, turbulent domestic data and worrisome overseas economic reports. Through the volatility, investors have seemed to reassess risk-reward parameters to the benefit of the small-cap market. Small-caps outperformed large-caps in January, and heading into the bottom of the first quarter of the year, many economists forecast the small-cap market to hold steady based on historical performance.

The Russell 2000 (IWM) is up 19.0% since its November lows vs. a slimmer gain of 11.8% in the Dow Jones Industrial average, which has ticked higher than 14,000 three times this year above a level it hasn’t seen in five years, and Wednesday coming within 100 points of a record high. The S&P also hit its highest levels since 2007, but are still one-upped by IWM, which as of Tuesday was up 170% from its March 2009 lows. Small-caps typically gain strength when the markets have been recovering from a recession, as evidenced by their performance since 2009.

Since that time, the IWM’s historical seasonal tendency is to scrape bottom in the October to November months, typically correcting itself until March before clenching a final high in early May.

A recent Wall Street Journal article pointed to data from Ned Davis Research, which shows that the relative performance of small-cap stocks vs. large caps has far-surpassed long-term averages and is near the highs reached in 2011. While IWM is down 3.9% from its high of $92.68 last week, economists aren’t writing-off this peak as the year’s grand finale.

Small-cap stocks have proven historical resilience. When the housing market collapsed in 2008, sucking the rest of the market into its crumble, small-cap stocks outperformed large-caps by more than 3% as investors learned that even bellwether companies can cripple. According to FactSet, small-caps have outperformed large-caps by roughly 40% in seven of the past 10 years. Furthermore, small caps outperformed large-caps both times the major markets lost value in this decade.

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