Small-cap stocks are badly lagging their larger peers so far this year, and some strategists foresee more downside in the space.
The Russell 2000 index soared 16 percent in the month after the U.S. presidential election as investors anticipated pro-growth, domestic-friendly policies like corporate tax cuts to be implemented under the Trump administration.
And because these policies could come alongside restrictive measures on global trade, smaller companies, which do more business domestically, benefitted even more than the large caps.
But now small caps are struggling, down almost 2 percent in the last month and just barely positive for the year. The S&P 500 has advanced nearly 6 percent year to date.
The lag is due in part to waning enthusiasm around the prospect of such tax cuts being implemented this year, as health-care reform and defense spending have appeared to move to the fore over tax policy, said Erin Gibbs, S&P Global’s equity chief investment officer.
However, the pullback seen here in small caps is still well within what Gibbs deems a “healthy” range. Small caps were trading at all-time high multiples earlier this month, she wrote, while expected earnings for the S&P 600 small-cap index are only slightly higher than those of large caps in the S&P 500.
And this week’s Federal Reserve meeting, in which the central bank is widely expected to hike its federal funds rate target, is also likely weighing on small caps.
“Often a few weeks before an upcoming Fed rate hike we have seen short-term ‘risk off’ trade. That usually includes high-yield bonds but also can include other riskier U.S. asset classes, like small caps,” Gibbs wrote Monday in an email to CNBC.
Ultimately, “you might actually want to look more at your large-cap stocks for now,” Gibbs said Monday in an interview on CNBC’s “Power Lunch” on the topic.
From a technical perspective, the Russell 2000 has now dipped below its 50-day moving average several times this year. To put that into perspective, the index closed 2016 more than 4 percent above its 50-day moving average.
“We’re just a bit worried about the fact that the Russell has been flirting with its 50 DMA. That line had been very strong support so far this year,” and its recent failure to hold that support has been “disappointing,” Miller Tabak equity strategist Matt Maley wrote in a recent note.
Such a breakdown is only a “small yellow flag” so far, but a move meaningfully below 1,350 would indicate a significant pullback, Maley wrote. The Russell 2000 closed slightly lower Tuesday, at 1,362.38.
Yet if history is any indication, small caps could see a turnaround at the end of this month and head higher, said Jonathan Krinsky, chief market technician at MKM Partners.
“It’s been a rough start for the small caps in March, which is historically the best month of the year for small caps. It’s averaged about a 3 percent gain over the last 15 years. So we think that creates the opportunity for the back half of the month,” Krinsky said Monday in an interview on “Power Lunch.”
Krinsky also noted that a buying opportunity could be near given its oversold conditions. In measuring market breadth — the number of stocks pulling back relative to the number of stocks advancing — small caps appear to be their most oversold since January 2016, he said.
And sentiment has shifted dramatically, with overall speculative positioning in small-cap futures shifting from being net long to net short. This could clear the way for a newfound bullish push.
“You have bullish seasonality, oversold readings and positioning is probably a tail wind at this point. So we think you should be able to head higher on small caps into the end of the month,” Krinsky said.