Bets on Biden-Led Stimulus Fuel Outperformance by Small Stocks -- Update
October 29 2020 - 5:14PM
Dow Jones News
By Amrith Ramkumar
Small stocks are outpacing larger companies by the greatest
amount in years so far this month, underscoring investors' bets on
Democrats gaining control in Washington and ramping up spending to
support the economy.
Despite this week's slide, fueled by rising coronavirus cases
around the world, the Russell 2000 of small-cap companies is still
up 3.6% in October. That compares with a 1.6% drop for the S&P
500 and would be the largest such outperformance for any month
since November 2016, the month President Trump was elected,
according to Dow Jones Market Data. The Russell is outpacing the
Dow Jones Industrial Average by 7.6 percentage points, which would
be the largest monthly gap in more than a decade.
In the past week, the Russell and S&P are down about 4.2%,
while the Dow has fallen 6%. The Russell has led this month even
though smaller companies would be hard-hit by any new lockdown
measures in the U.S. Earnings at these companies tend to rise and
fall with the performance of the economy, but investors are
anticipating that a victory by Democratic presidential nominee Joe
Biden will lead to larger spending programs on everything from
infrastructure to renewable-energy projects.
Similar wagers were made four years ago after Mr. Trump's
surprising victory, when investors bet that spending on
infrastructure programs and deregulation would support small-caps.
Many of those wagers unwound after a large infrastructure bill
never materialized, and small companies continued lagging behind
their larger peers as they have for much of the past decade. Since
the 2016 election, the S&P has risen 55%, while the Russell is
up 31%.
But nearly four years later, investors are favoring small stocks
again. Many investors are hopeful that greater fiscal spending can
offset corporate-tax increases or greater regulation that many
investors expect in a "blue wave" scenario that sees Democrats win
the White House and control in the Senate.
"There is this notion that the fiscal stimulus will overwhelm
any tax implications that a blue wave might bring," said Dan Cole,
co-manager of the Columbia Small Cap Growth Fund. He has been
increasing holdings of businesses like Planet Fitness Inc. and
tax-software company Avalara Inc., recently.
The Russell 2000 is narrowing some of its longstanding gap with
the S&P, which has been lifted lately by large technology
companies like Apple Inc. and Microsoft Corp. With a market value
around $2 trillion, Apple is roughly as large as the entire Russell
2000 by itself.
The Russell's recent outperformance comes with some investors
wagering that more government spending will lift so-called cyclical
companies, whose fortunes are tied to the economic outlook. Those
include smaller companies, banks, manufacturers and commodity
producers that tend to perform well as the economy exits a
recession. In another sign investors are positioning for more
stimulus, longer-term Treasury yields have risen lately, a
development that signals traders are positioning for stronger
growth and inflation. Bond yields climb as prices fall.
Some of the gains also mimic investors' recent bets on larger
companies that help with remote work and learning or leisure while
stuck at home. Smaller companies lifting the Russell with gains of
at least 30% this month include home-goods retailer Bed Bath &
Beyond Inc., home-fitness firm Nautilus Inc., action-camera maker
GoPro Inc. and organization-products seller the Container Store
Group Inc.
Still, concerns about rising coronavirus cases and the prospect
of fresh lockdown measures could pose a new threat to the
outperformance in small-caps. Oil prices and shares of energy
companies have been among the market's worst performers this week,
a sign investors are growing concerned about fuel demand and the
economic outlook. Because profits for small caps would be hit
harder by any new restrictions, many analysts say further stimulus
measures will be needed to support the group until a coronavirus
vaccine is distributed.
"The economy doesn't have to get back to normal. We just have to
have visibility into it and confidence that it's coming," said Jeff
Buchbinder, equity strategist at LPL Financial. LPL recently
boosted its view on small-caps to in line with its market benchmark
from a negative stance.
Recent negotiations between Democrats in the House of
Representatives and the White House over a second round of
coronavirus stimulus have stalled, amplifying questions about
whether the two sides will reach a deal after the election but
before the next administration begins.
If a deal is reached, some investors think smaller companies are
well positioned to climb further. The Russell 2000 last hit a
record in August 2018 and has trailed major indexes for years,
giving it room to rise in the months ahead, some analysts said. The
Dow industrials hit their last record in February, while the more
technology-laden S&P 500 and Nasdaq Composite reached new highs
in early September.
Still, some traders caution that the economic recovery is
already slowing down, a trend that could prompt investors to once
again favor larger companies more directly tied to technology and
remote working.
Some market watchers are also nervous about the role of
increased speculation by individual investors using apps like
Robinhood in driving the rally. Trading activity in companies with
share prices below $5 has risen recently, and some investors have
even been buying shares of companies on the verge of
bankruptcy.
Rental-car company Hertz Global Holdings Inc. has been one of
the Russell 2000's top performers this month on a percentage basis,
with its shares rising 60% to $1.78 after it lined up $1.65 billion
in financing to carry itself through bankruptcy.
"Because small-caps are a riskier asset class, it is a good
proxy for investors' risk appetite," said Angelo Kourkafas,
investment strategist at Edward Jones. "You can definitely connect
the two." The firm is recommending investors generally trim
positions in areas that have outperformed lately like large
technology stocks and bolster holdings in areas lagging behind like
small-caps.
Write to Amrith Ramkumar at amrith.ramkumar@wsj.com
(END) Dow Jones Newswires
October 29, 2020 16:59 ET (20:59 GMT)
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