The last time the Russell 2000 (^RUT) hit a new high was in March of this year, peaking at just over 2,360 points, while the S&P 500 (^GSPC) continues to break new highs. According to DataTrek Research, however, there are two factors that will determine whether the Russell 2000 can outperform the S&P.
“The first is US high yield corporate spreads over Treasuries, which play an outsized role in the Russell’s relative performance,” DataTrek Co-Founder Nicholas Colas said in their Oct. 28 DataTrek Morning Briefing.
Colas referenced a chart depicting high yield spreads back to 2006, noting that “almost all times” when the Russell 2000 outperformed the S&P 500 came when high yield spreads were “tightening noticeably.”
“The only exception is 2008, when the Russell ‘outperformed’ by only dropping 34 percent to the S&P’s 37 percent decline,” Colas said. “It was modestly helpful to have less large cap Financials exposure during the Financial Crisis, of course.”
The second factor, according to Colas, pertains to the Russell 2000’s “heavy overweight” on health-care companies. He said that the issue lies in the fact that small-cap health-care has not generated much momentum in contrast to large-cap health care over the past year.
“The index has a 19.6 percent allocation to [the health-care] sector versus 12.3 pct in the S&P 500,” Colas added. “Small cap Health Care (using the S&P 600 (^SP600) sector as a proxy) has been going nowhere this year, only up +4.5 pct YTD and losing steam as the year progresses. That’s something of a surprise, since large cap Health Care (a group we like) is up +15.9 pct and moving up with the recent rally in large caps.”
DataTrek Research, co-founded by Colas along with Wall Street researcher Jessica Rabe, provides a daily financial newsletter to hedge funds, asset managers, RIAs/family offices, and other investment firms.
DataTrek will continue to remain Neutral on U.S. small caps. They last upgraded this rating from Negative to Neutral in late July. According to Colas, however, DataTrek views the small cap energy sector favorably, pointing at the Invesco S&P SmallCap Energy ETF (PSCE).
Ultimately, he believes it may be difficult at the moment to be enthusiastic about the Russell 2000 given lackluster performance in small cap healthcare and high yield corporate spreads tight to treasuries.
“And maybe small cap Health Care can find its footing, but check out the chart for PSCH (PSCH) (S&P 600 Health Care) and you’ll see that’s a hard ask,” Colas said. “We continue to like Small Cap Energy (PSCE), but aside from that we remain at best neutral on US small caps.”
Thomas Hum is a writer at Yahoo Finance. Follow him on Twitter @thomashumTV