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Small caps: Unlikely heroes of an aging bull market?

By: Tom Goodwin, Sr. Research Director

July marked a milestone for the current bull market – now the second longest on record. While it certainly does not feel like a momentous occasion, the data indicates otherwise.[1] You might say, this is just a very slow moving bull whose pace is to a large extent dictated by slow underlying economic growth. In such slow-growth economic conditions, the perceived stability of large cap companies may sound alluring but history tells different story.

Intuitively, one might expect that large cap companies, with their well established businesses and revenue streams, would outperform their smaller, growth-oriented counterparts during these sluggish periods. However, a look back at the past reveals that at times like these, small caps actually tend to outperform large caps.[2]

As illustrated below, the Russell 2000 Index measuring small caps outperformed the Russell 1000 Index measuring large caps during the majority of years in which US GDP growth was less than 3%. Since the start of the measurement period in 1979, small caps averaged an annual excess return of 8.1% over large caps during these slow-growth years.[3]

 

If slow growth is defined as annual GDP growth below 3%, then our current environment certainly falls into this category. Since the Great Recession ended in June 2009, US GDP growth has averaged less than 2% per year.[4] And if recent Fed forecasts become a reality, we could be facing similar lethargic growth over the long run.[5]

As the bull market continues on its slow march forward, market participants may want to keep an eye on the performance of the small cap segment of the market. Serving as a benchmark for over 96% of US small cap-focused investment products[6], the Russell 2000 Index stands to be a robust measure for these unlikely heroes of slow bull markets past.

For further research on this subject, please see “The Russell 2000 Index, Small cap performance in a slow-growth economic environment.” 


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[1] Source:  Bloomberg, S&P Dow Jones. Based on historical performance of the S&P 500

[2] As measured by the Russell 2000® for small caps and the Russell 1000 for large caps

[3] As measured by the average annual performance differential between the Russell 2000 and the Russell 1000 from January 1, 1979 to December 31, 2015.

[4] The Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) determined that the economic contraction began in 12/2007 and ended in 6/2009, the longest peak-to-trough contraction since the Great Depression.

[5] Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents, Federal Open Market Committee Minutes, December 2015.

[6] Sources: Morningstar Direct, as of May 4, 2016.  Includes institutional funds, separate accounts and ETFs. “Russell 2000” includes variants (Defensive, Dynamic, Growth, Value, 50-50 SC/Micro).

 

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