Market Health

Small Caps Are Almost Guaranteed to Outperform in 2021

Whenever there’s a downturn, sell-off or collapse, small caps tend to get hit the hardest.

These are often referred to as “frontline businesses.” A considerable portion of these rely on the domestic economy – instead of international markets – for revenue. And when the American consumer gets sideswiped by a black swan, like COVID-19, small caps are the most exposed.

Looking back at 2020, we see that the Russell 2000 Index suffered a much steeper drop than its larger brethren did.

Russel 2000 Index vs Broader Markets

Small caps shed more than 40% of their value at their lowest point in March.

They recovered like the rest of Wall Street. But as we can see from the chart, the Russell 2000 underperformed its larger counterparts for much of the year.

However, the tide is shifting. And investors need to pay attention to it.

Think Small for Big Returns

There’s been a dramatic shift into small caps over the last couple of months because the mood has changed in this country.

There’s growing optimism about the U.S. economy fully reopening sooner than previously thought.

The vaccine rollout is still full of frustrations. But we’re now winning the war against COVID-19.

At the moment, nearly 28 million Americans have received at least one dose of a COVID-19 vaccine. That represents more than 8% of the U.S. population. And that’s more than were infected with the deadly virus in the U.S. The percentage of new positive COVID-19 cases – especially among the older population – is also in sharp decline across the country.

Next, we have a new administration in charge. And with the Democrats controlling the House of Representatives, Senate and White House, there aren’t many obstacles for their fiscal stimulus plans.

On Friday morning, we saw that play out as the Senate passed the $1.9 trillion COVID-19 relief package 51-50. And it should easily clear the House.

The expectations of this exact scenario ignited the massive rally in small caps since November.

Over the past six months, the Russell 2000 has rocketed nearly 46.5% higher!

Russel 2000 Index vs Broader Markets

That’s nearly three times the performances of the Dow Jones Industrial Average and the S&P 500 Index. And it’s double that of the Nasdaq during the same span.

But as we can see, since the U.S. presidential election, the small cap rally has seriously accelerated. And I don’t expect to see a slowdown anytime soon.

Let the Party Continue

Small caps are pummeled fiercely on the downturn. But they more than make up for it during the leg higher. Simply put, they rebound faster.

And when coming out of recessions, that momentum continues. Since 1980, we can clearly see that the Russell 2000 has outperformed the S&P 500 by an average of 10.1% in the 12 months following a recession’s end. That increases to an average of 12.5% in the two years after economic expansion begins.

Small Caps Historically Outperform Large Caps Coming out of Recessions

From a fundamental standpoint, there’s reason to believe that there is even more upside for small caps. Earnings on the Russell 2000 are projected to increase 150% this year, compared with the 23% increase forecast for the S&P 500.

Small caps are my favorite companies to cover and invest in. During the first 10 months of 2020, these great growth opportunities underperformed their larger counterparts. But they’ve been reenergized in recent months, racing higher to make up for lost time. Using history as our guide, we can expect this outperformance to continue throughout 2021.

So investors looking for big gains this year need to think small.

Here’s to high returns,

Matthew