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Small caps may turn mighty, strategists say

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Improving economic data and bullish technical signals could give a boost to shares.

Smaller U.S. stocks could be set for a big run higher into the end of the year, according to Wall Street.

A combination of improving economic data, bullish technical signals and a seasonal effect could give a boost to the shares, which have lagged their larger peers for much of the last year, said strategists from Tallbacken Capital Advisors to Saxo Capital Markets.

“The technical condition on the Russell 2000/S&P 500 price ratio continues to push higher after several quarters of severe decline,” Tallbacken CEO Michael Purves wrote in a note Monday. “If risk is on into year’s end, we won’t be surprised to see the relative performance continue.”

The Russell 2000 Index — a benchmark for U.S. small caps — climbed 2.1% Monday to its highest since October 2018, outperforming the broader S&P 500 Index which rose 0.8%. The gauge of smaller companies was about 7% below its all-time high as of 9:50 a.m. EST on Tuesday, while the S&P 500 traded at a fresh record.

Improving data

A raft of good economic data last week, from manufacturing to consumer sentiment, may be benefiting the Russell, according to Kay Van-Petersen of Saxo Capital Markets in Singapore. Smaller companies are often seen as closely linked to the domestic economic cycle.

The improved performance in the small-cap index could also be coming from hopes of mean reversion versus bigger stocks, or even a short squeeze, Van-Petersen added.

Evercore ISI technical analyst Rich Ross sees about 10% short-term upside for IWM, an iShares exchange-traded fund that tracks the Russell 2000. The ETF has broken a year-long “stubborn” technical resistance level, with breadth expanding — a bullish sign — he wrote Monday.

Seasonal move

Meanwhile, Tallbacken’s Purves noted the median December performance for the Russell 2000 is a 2.5% gain, in data going back to 1979, and that about a quarter of those months saw a return of more than 5%.

“Of course, there are plenty of negative Decembers for the Russell 2000, and some can be sharp,” he said. “But if risk is on, there is a good chance for it to continue to gain meaningful ground into the end of the year and perhaps a lift higher in January as well.”