After nearly two years of pain, small stocks are exploding higher.
Every shred of evidence I have collected over the past several weeks is pointing to an extended surge in smaller stocks. Political, economic and market cycles are aligning perfectly in our favor as the market kicks off 2017 in style.
Of course, the financial media are fixated on Trump tweets, Dow 20,000 and other market sideshows.
Ignore these media-driven sideshows. The real action is happening under the surface of the major averages. Even yesterday as the Dow powered ahead by 60 points for a 0.3% gain, the small-cap Russell 2000 blasted higher by more than 1.6%.
It’s official: small stocks have finally snapped out of their slumber. Their path hasn’t been perfect. But after a pre-election pullback in October, small caps are finally back on top again. As of early December, the small-cap Russell 2000 had jumped 40% above its February lows thanks in part to an incredible 14-day run to cap off November trading. That was the index’s longest winning streak in more than 20 years.
This is how big changes in trend happen. One second, everyone hates small-caps. Just when the last seller leaves the building, a furious rally begins to take shape. And the powerful rally that sent the Russell to new highs last month is just a preview of what’s about to bubble up in 2017.
Here’s why the sector is ripe for more gains…
In the stock market, performance is everything. No one wants to own a losing stock — let alone fill their portfolio with names from a down-and-out sector.
Since small-caps are still on the naughty list, most investors don’t believe the current rally will stick. But if we turn to the numbers, history tells us that the rally is just getting started.
Value Walk notes that the Russell 2000 finished the year only 7.2% above its summer 2015 highs. According to their data, the market has seen 12 declines of 15% or more in the Russell since its inception. The median return for the recoveries that followed was an incredible 98.8%. For context, the rally off the February bottom has produced gains of 45% so far.
We aren’t even halfway there…
What does all this mean?
A return to business as usual for the outperforming small-cap sector.
“Based on history, we see more running room for small-caps,” Value Walk explains. “The market and economic environments look promising. The current cycle has also seen more return dispersion and declining correlation, a steepening yield curve, and an increase in bankruptcies—all signs of growing normalization.”
The Russell is once again creeping up on new highs. That’s going to lead to some new investing opportunities for us as the year progresses.
As we told you last month, smaller stocks have been some of the best performing names on the street since the election. We’re going to see some shakeouts after this powerful run higher. But small stocks are already blasting out of consolidation patterns after taking a holiday break.
In fact, the Russell looks primed and ready for the next round of its comeback move. If history is any guide, more gains are on the way…
This story originally appeared in the Daily Reckoning