US indices: Three reasons the Russell 2000 has been crushing Nasdaq and S&P 500

Why small-cap stocks have (and may continue) to outperform their large-cap rivals

While there were (and will continue to be) dark days ahead, the 9 November announcement of the highly-effective Pfizer-BioNTech vaccine has apparently marked the beginning of the end of the COVID-19 pandemic.

With a few exceptions, vaccine rollout is still frustratingly slow across the globe, but traders immediately recognized the light at the end of the tunnel and started to price in a roaring “reopening” trade the moment the vaccine results were announced. As the chart below shows, the large-capitalization S&P 500 and tech-heavy Nasdaq indices that dominated throughout the pandemic have rallied an impressive 10-12% in the 3+ months since that fateful day, but the 30% surge in the small-cap Russell 2000 index has absolutely dwarfed it larger rivals:

Source: TradingView, GAIN Capital

While countless factors have contributed to this impressive move, there are three primary factors driving the Russell’s outperformance:

1) The “reopening trade”

Generally speaking, the stocks that outperformed throughout Q2 and Q3 of 2020 were the primarily technology sector names that enabled both individuals and businesses to adapt to global lockdowns and operate with some semblance of normalcy (think of the usual FANMAG culprits, as well as digital-first companies like Zoom Video and DocuSign). Now, with multiple effective vaccines in distribution, traders are looking ahead to global consumers returning the “the real world” of brick-and-mortar businesses, which are more often the types of smaller companies that make up the Russell 2000.

2) Potential for easier access to capital

In a distinct but related development, many smaller publicly-traded stocks don’t have the deep banking relationships and access to capital of their large-cap brethren. As banks reined in lending during the pandemic and focused on keeping their highest-value corporate clients intact, smaller companies were a massive disadvantage, with many unable to raise the funds needed to “bridge the gap” to the a post-COVID environment. The chart below shows that the percentage of banks tightening lending standards on small businesses is on par with the GFC peak in 2009:

As Mark Twain once reportedly said, “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.” The ongoing global distribution of vaccines is a sign that the sun might once again be peeking through the clouds.

3) Valuations

The most basic and straightforward of investment anchors may also be providing a tailwind for small-capitalization stocks. Using the S&P 500 (large-cap), S&P 400 (mid-cap), and S&P 600 (small-cap) as proxies, smaller companies now trade at a meaningful discount to their large-cap rivals for the first time in about 15 years:

Source: Yardeni Research

After the performance that we’ve seen over the last couple of months, we could see a fourth factor start to contribute to small-cap outperformance moving forward: momentum. Traders have a tendency to buy what’s been outperforming lately, so don’t be surprised if small-cap indices like the Russell 2000 continue to outperform in the coming months!

Learn more about index trading opportunities.

More from Indices

Disclaimer: The information on this web site is not targeted at the general public of any particular country. It is not intended for distribution to residents in any country where such distribution or use would contravene any local law or regulatory requirement. The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warranty that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.

Futures, Options on Futures, Foreign Exchange and other leveraged products involves significant risk of loss and is not suitable for all investors. Losses can exceed your deposits. Increasing leverage increases risk. Spot Gold and Silver contracts are not subject to regulation under the U.S. Commodity Exchange Act. Contracts for Difference (CFDs) are not available for US residents. Before deciding to trade forex and commodity futures, you should carefully consider your financial objectives, level of experience and risk appetite. Any opinions, news, research, analyses, prices or other information contained herein is intended as general information about the subject matter covered and is provided with the understanding that we do not provide any investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all investment, legal, or tax matters. References to or GAIN Capital refer to GAIN Capital Holdings Inc. and its subsidiaries. Please read Characteristics and Risks of Standardized Options.

Open an Account