Market Segment Cyclicality and the Rise of Small Caps

As we surpass the one year anniversary of the Covid-19 pandemic and accompanying market sell off, it is worth looking back on the ensuing market cycles that resulted. From the middle of February to the middle of March 2020 the Russell 2000, the small-cap index, plunged more than 40% while the S&P 500, the large-cap Index, was off around 33%.  We saw that larger companies were less affected on the downside and then persisted to bounce back more sharply as the widespread ‘work from home’ period set in and boosted some of the largest names in the index.

Towards the end of 2020 we started to see a shift when positive news of vaccine trials became a kernel of hope for a return to a sense of normalcy. When this positive news came out, there was a shift and suddenly smaller firms, whose stocks were well priced, started to look like they could outperform the large companies in the economic recovery in 2021. In general, small-cap stocks are more cyclically biased than their large cap peers and are more closely linked to the health of the economy.

As Q1 of 2021 comes to an end, the markets are still hopeful about smaller companies’ future earnings. We know the pandemic battered many companies, yet some of the smaller ones caught a tailwind by being well positioned to take advantage of pandemic produced trends and nimbly shift and accelerate with said trends. Great examples of this are the healthcare and information technology sectors with the idea of consumer-directed healthcare and telehealth. Small-cap companies in this space have benefited drastically from this innovation.

All this being said, as we pull back to look at the big picture of investing, it reminds us once again of the importance of diversification. The more diversification a portfolio contains, with exposure to different sectors and segments, the higher likelihood of participating in each part of the market cycle.

~Emily Lucero