syahrir maulana/iStock via Getty Images
The S&P 1500 (NYSEARCA:SPTM) is “worth a look” to get incremental exposure to U.S. small caps while keeping a bias to large caps, according to a DataTrek Morning Briefing report.
The Russell 2000 (NYSEARCA:IWM) had a two-day return of 4.7% due to markets now believing the Federal Reserve will cut rates by 125-150 basis points over the next year, a better confidence in the U.S. economy and its growth, and money managers underweighting small caps because of the outsized run in large caps over the last 18 months, Nicholas Colas, co-founder of DataTrek said.
The large cap/small cap returns are expected to be equal during the second half of the year, while small caps are expected to do better during the third quarter, he added.
To explain this, Colas looks at the U.S. high yield corporate bond spreads over treasuries. When spreads have declined — such as they did in 2010, 2012, 2013, 2016, and 20202 — the Russell (IWM) outperformed by around 0.4 to 11.8 percentage points, relative to the S&P 500 (SP500).
When spreads increased or were stable — including years 2011, 2014, 2015, 2017-2019, 2021, and 2022 — the Russell (IWM) underperformed by around 6 to 13.9 percentage points.
But over the past 18 months, things have changed: the lower high yield corporate bond spreads (4.8 down to 3.4 percentage points) should have had the Russell (IWM) outperforming the S&P. Instead, it underperformed by 9.4 percentage points.
Also, the Russell (IWM) lags the S&P 500 (SP500) year-to-date at 6.2% vs. 17.7%.
“This break with historical precedent is, of course, due to the rally in large cap tech (up 46.3%),” said Colas. “But it is important to note that the Russell has done well over the last year and a half, up 22% since the start of 2023.”