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The small and micro-cap stocks gathering gains

The rally in small-cap stocks at the end of 2020 looks set to continue, with even micro-cap stocks moving up so far in 2021.

This article was originally published on Opto – Understand What Really Moves Markets. 

Their success has been so complete that small- and micro-cap indices have been outperforming their large-cap counterparts.

The Russell Microcap Index [RMIC] has gained 28.83% for the year to 12 February’s close and 54.7% in the past year. Meanwhile, the Russell 2000 Index [RUT], which is made up of the smallest 2,000 stocks in Russell 3000 Index, was up 17.65% and 35.99% in the same periods. For comparison, the S&P 500 has climbed just 6.33% so far in 2021 and 16.75% in the past 12 months (through 12 February’s close).

However, this only tells part of the story. Micro-cap funds have seen higher than usual outflows in recent months, according to Bloomberg. This has been driven, in part, by the penny stock fever that has gripped retail investors, especially those who frequent Reddit forums.

Having seen small-cap stocks including AMC [AMC] and GameStop [GME] rally hard in the last couple of weeks, retail investors are increasingly likely to be drawn to smaller companies as a way of getting a quick return. Micro-cap and small-cap ETFs don’t appear to offer the same excitement.

Other small-caps have found themselves swept up by the Reddit craze as a result. For example, Fossil Group’s [FOSL] share price was up 88.29% so far this year to 12 February’s close. In recent weeks, the stock has fallen 43.78% since rocketing to a 52-week high of $28.60 on 27 January.

Small-caps attract bulls 

The recent share price moves have been astronomical, but there is an argument to be made that the movement highlights the previous undervaluation of some small-cap stocks. At least this is what Jonathan Heller, president of KEJ Financial Advisors, thinks. Heller has suggested that the market has been mispricing cheap companies like Fossil Group.

“[Fossil Group] was in better shape from a balance sheet perspective than the market was giving it credit for,” he writes on RealMoney.

Small-caps could still see their share prices drop further in the near-term, if the broader market were to quieten down following the recent retail frenzy. However, many companies should have the wind behind them throughout the rest of the year. In particular, consumer discretionary and consumer staples stocks, like Rite Aid [RAD].

Boris Schlossberg, managing director of FX strategy at BK Asset Management, recently told CNBC’s Trading Nation that small-caps are well placed to have a strong 2021. Their success could be accelerated by Biden’s haste to sign-off on coronavirus relief packages and get the ball rolling on a nationwide vaccine programme.

“You have amazing operational leverage on the small-cap size because those companies that survived now have a chance to really rebound with much leaner staff, and therefore much better profit margins,” Schlossberg considers.

Small but mighty

Small-caps are often cyclical, but more money could flow into smaller companies, even if it means defensive stocks and mega-cap tech companies see their share prices tumble, according to Tavis McCourt, a strategist at Raymond James. In a research note, seen by Barron’s, McCourt stressed that the price-to-earnings ratios of many of these tech stocks are too high right now.

Todd Gordon, founder of TradingAnalysis.com, prefers not to think of a continued upswing for small-cap stocks as a David versus Goliath situation. Also speaking to CNBC, Gordon argues: “You’ve got to take more of a step back and not say small caps in general are going to outperform. I actually think we want to look at small caps and break it into value versus growth.”

Nonetheless, it’s likely that many small-cap stock prices will continue to rise as the recovery from the coronavirus pandemic gathers pace and retailers, hotels and restaurants receive a welcome boost.

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