November Charts of Interest: Small-Cap Pain

Though I typically start my monthly charts of interest commentary with charts created by others, I’m pivoting this month and going with one I put together first. Call it editor’s choice.

Small-cap stocks have yet to sustain a breakout from their last bear market. Though the Russell 2000 index rose more than 20% above last year’s low—the threshold for ending a bear market—over the summer, it has since reversed course. Late last month, the index neared its bear market lows.

The chart below uses the iShares Russell 2000 ETF (IWM) as a proxy for the Russell 2000. The other exchange-traded fund (ETF), the iShares Core S&P 500 ETF (IVV), is a proxy for the S&P 500 index. The difference between the two since March is stark.

Source: StockCharts. Data as of 11/15/2023.

Interest rates are playing a role. As the bond market went a bit bonkers a few weeks ago, small-cap stocks acted as if they took a hard punch to the jaw. Small companies tend to be riskier than their larger counterparts.

They Are Cheap Though

I’ve written before about how small-cap stocks are cheap relative to large-cap stocks. This continues to be the case. As of the end of October, the median price-to-book-value (P/B) ratio for S&P SmallCap 600 index stocks was 1.52. Meanwhile, the median price-to-book ratio for S&P 500 stocks was 3.01. This continues the ongoing historically wide valuation difference between the two.

Source: LSEG and AAII. Data as of 10/31/2023.

The U.S. Is on Quite a Streak

Among the big arguments for diversification is that not all investments perform the same, even within asset classes. Such is the case for domestic and foreign stocks. U.S. stocks have delivered higher returns than their international counterparts for 12.6 years. This streak compares to the historical average of eight years, according to Hartford Funds.

Source: Hartford Funds. Data as of 9/30/2023.

How Dare You Miss!

Third-quarter earnings season has been good on the earnings surprise front. As of last week, more than four-fifths (81%) of S&P 500 companies reported earnings that topped analysts’ expectations.

However, approximately 9% have missed expectations. Traders have not reacted kindly. Those stocks have experienced an average price decrease of 5.2% during the period starting two days before the earnings release and ending two days after the earnings release. FactSet says this is not only greater than the average price decrease of 2.3%, but it is on pace to be “the largest average negative price reaction to negative [earnings] surprises reported by S&P 500 companies for a quarter since [second-quarter] 2011 (–8.0%).”

Talk About a Tough Crowd …

Among the things analysts are cutting back on is their plaudits, reports Bloomberg. The amount of verbal praise given during third-quarter conference calls is running 35% below the average of the past three years. “Even when the numbers are good, analysts may refrain from compliments when the economic backdrop appears to be deteriorating,” suggests Bloomberg.

Bonds Are Back?

One argument being made is that bonds are currently attractive. This is largely based on the premise that real (inflation-adjusted) yields are positive for the first time in many years, as this chart from Research Affiliates shows. Even in the bond market, pundits and strategists operate with cracked crystal balls, so there is no telling how bonds will actually fare in the future.

If interest rates have peaked, then bonds could have the potential to realize capital gains going forward—unlike certificates of deposit (CDs) and money market accounts. We still think bonds should be considered within the confines of your tolerance for volatility and allocation needs. While bonds provide income and preservation of capital, stocks provide much more capital growth, albeit with greater short-term volatility.

More Than Just Books

Finally, Amazon is closing in on Walmart in terms of revenues. The difference has narrowed from Walmart having 2.0 times as much revenue five years ago to just 1.1 times more revenue now, according to Charlie Bilello. Amazon Inc. (AMZN) has more sources of revenue than Walmart Inc. (WMT), so it’s not an apples-to-apples comparison (even though both sell apples and Apple products). Still, it just shows how big Amazon has become.

Now, if you will excuse me, I think someone just left a package at my front door …