Wall Street bets on Main Street
Investors fueled by news of progress in vaccine development are buying up shares in small companies likely to benefit from a possible US economic recovery.
Successful vaccine test results announced this month by Pfizer and Moderna have prompted a tough capital turnaround on Wall Street away from Big Tech and beneficiaries from restrictive measures and lockdowns such as Zoom, Teladoc and Netflix..
Instead, investors are investing in the Russell 2000, a small-cap stock index whose value is largely tied to the whims of the US economy. This month alone, the Russell 2000 Index is up 15%.
WallStreetBets and GameStop.
If that growth continues, it will be the index's best monthly gain since 2011 and just under its best month since its 1984 launch..
Not only is the Russell 2000 on the cusp of a record month, but the index also hit an all-time high last week. This is important because, unlike many other records recently set by S&P 500, this was his first record since 2018. And this suggests that there may be even more opportunities for its further growth.
According to Nicholas Kolas (Nicholas Colas), co-founder of DataTrek Research, typically takes small-cap companies four or five years to reach record highs after a recession. It only took eight months this time.
«Hope is one of the main drivers of cyclical valuation and stock returns», – wrote Kolas in a note to clients on Wednesday. «Traditionally, these hopes are diminished when the Fed starts raising rates. We know this won't happen anytime soon.».
The move towards small-cap stocks has boosted the value of these companies. According to Refinitiv, Russell 2000's earnings increased 31 times as of Wednesday. This is much higher than the 10-year average of a multiple of 23.
UBS Wealth Management strategists told clients this week that smaller stocks are likely to outperform larger stocks next year.
«If investments in 2020 were to be resilient, large and American, then we think 2021 will be cyclical, small and global as sectors and markets hit hard by the lockdown begin to revive.», – strategists wrote.
Of course, the growth of small-cap companies comes at a time of heightened pandemic concerns. The number of cases of infection with Covid-19 is skyrocketing, and the number of hospitalizations across the country is rising sharply.
New York City public schools are closing again. City canteens and gyms may also be closed after a few weeks. United Airlines warned on Thursday of increased cancellations and slower bookings due to escalating pandemic.
Pandemic fears reappear on Wall Street: S index&P 500 falls for the third day in a row.
«The vaccine is the light at the end of the tunnel», – said Liz Ann Saunders (Liz Ann Sonders), Chief Investment Strategist Charles Schwab. «But we're still in the darkest part of the tunnel».
Saunders warned that if the economic recovery is delayed for any reason, investors could step back out of small-cap companies and return to the market leaders who keep people alive and working at home..
Unlike indices S&The P 500 and DIJA, which are home to multinationals such as Nike, General Electric and Apple, the Russell 2000 is more of a playground for the US economy.
The fund's average market valuation is only $ 660 million. Its largest contributors are Penn National Gaming, Sunrun, Deckers Outdoor and Caesars Entertainment – none of which are worth more than $ 14 billion..
Small-cap stocks crashed in the midst of the pandemic because, unlike larger companies, they always have less room for error. Their balance sheets tend to have less cash and more debt, so when business dries up during a recession, financial troubles follow..
According to Liz Ann Saunders of Charles Schwab, at the end of October a staggering 48% of the companies participating in the Russell 2000 were unprofitable.
«It is believed that perhaps this is the worst thing that we can get (in the future)», – Saunders said, adding that the last time the loss peaked, the index rose sharply.
Small-cap stocks are also benefiting from the Federal Reserve's extremely aggressive response to the pandemic. By cutting interest rates to zero and buying corporate debt, including junk bonds, the Fed successfully unblocked frozen credit markets last spring.
This is very important for small-cap stocks, Saunders said, because most of them are considered «zombie companies», which means they don't make enough money to even pay interest on the debt.
So if credit markets are frozen again, perhaps due to a worsening pandemic and Washington's failure to provide additional stimulus, small-cap stocks could plummet..
Market «bulls» are clearly betting that this will not happen.