There continues to be hysteria and paranoia around what some are calling a ‘melt-up’ in stocks – a continuous drift higher with no apparent reason or catalyst. But is this really the case, if we look under the hood? Are stocks really moving up ‘for no reason?’
As the Federal Reserve continues to push interest rates higher, why are small-cap stocks outperforming larger, more established large-cap stocks? The reason is simpler than you’d think. A stronger dollar drags on the balance sheets of larger companies that are sensitive to dollar fluctuations. Smaller companies, on the other hand, not only make more of their money within the US, but they also are essentially taking in less dollars, meaning they are less sensitive to moves in the dollar.
Thus the continued risk-on rally in small cap stocks. Small cap stocks are sought and bought when the risk/reward scenario in large established companies just isn’t enough. Interest rates are basically forcing investors to seek more risk, in the form of high-risk, small-cap stocks.
There’s another reason why we’re seeing small cap stocks continue to squeeze higher: there are simply less of them, from a market share perspective. The S&P 500 makes up 80% of the investible stock market, while small caps only comprise 10%. When there are fewer risky stocks to choose from, they command a higher premium and tend to shoot up faster than the large cap stocks. Low supply and high demand mean small cap stocks can and do move faster.
Here’s more supporting evidence: we’re seeing new highs in the advance-decline lines for small-cap, mid-cap, Nasdaq 100 and S&P 500; everything essentially. The advance-decline lines represent how many stocks are rising each day versus falling, we’re essentially seeing fewer and fewer stocks falling relative to the market each day. Small caps are spearheading the move, and projecting the behavior of mid-cap and large-cap stocks.
All of this market movement has continued in the face of wild fluctuations in bonds abroad, as well as a brief dip in dollar strength. Despite the drama and market noise, stocks are signaling an ability to continue their ramp up amid even higher interest rates, to the tune of approximately 3.5%, according to Art Hill, via financialsense.com.
What’s the moral of the story? Small-cap stocks are leading the way in terms of market strength and price direction, and are signaling continued momentum to the upside.
Do you agree? If you think the market still has some room to run, you might want to take a look at IWM – the ETF that tracks the Russell 200 Small Cap Index. If you REALLY think there are gains to be had in small caps, take a gander at IWC – the iShares ETF that tracks micro-cap stocks.
If you think we’ll see more strength in large caps, SPY – the SPDR ETF that tracks the S&P 500 might be your answer.
Choose wisely, and happy hunting!