Small caps were the talk of the town during the Fed pivot.
Since the Federal Reserve held interest rates steady on November 1, the Russell 2000 (^RUT) has risen more than 20%. The widely referenced index is used to aggregate small-cap companies, many of which have sold over the past year and a half amid fears that higher interest rates would pressure the companies.
But as investors have become increasingly confident that the Federal Reserve is moving closer to cutting interest rates rather than raising them again, investors have snapped up interest rate-sensitive sectors.
Small caps have become favorites in this group as many strategists have emphasized that indexes like the Russell 2000 are trading at cheap valuations compared to historical norms.
The chart above shows the valuation of profitable companies in the Russell 2000. (Fidelity, FMRCO, Bloomberg)
However, if you ask further about small caps, most strategists find that they are not directly talking about the Russell 2000 per se.
Charles Schwab chief investment strategist Liz Ann Sonders emphasized to Yahoo Finance Live that the Russell 2000 does not use a profitability filter. She estimated that 40% of the companies in the index are not profitable and 31% of stocks are “zombie companies,” meaning they will not become profitable and barely survive.
“I don’t recommend the index,” Sonders said. “But if you're looking for an index as a source of ideas, the S&P 600 (^SP600) inherently gives you a higher quality index because of that profitability filter.”
Matt Stucky, a senior portfolio strategist at Northwestern Mutual Wealth Management, is overweight small caps. But he also sees a crucial difference in what exactly that means. He also enjoys fishing in the S&P 600.
“This is not unusual for smaller companies that are growing rapidly, but in our view we believe it makes sense to overweight factors such as profitability.”
Last month, the returns of the two indices were about the same. However, for five years, the value-oriented S&P 600 has outperformed, growing about 65%, compared to the Russell 2000's return of 55%.
Source: Yahoo Finance
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