The Russell 2000 Index, which is generally considered to be the benchmark index for small-cap stocks, is doing well and has been doing well for some time now. The index is at an all-time record high, having recovered extremely well since the subprime mortgage–induced financial crisis. Its performance is quite amazing considering the weak gross domestic product (GDP) growth we’ve been experiencing.
Small-cap stocks, like the rest of the stock market, have been given a boost by the Federal Reserve’s easy money policies, but it’s not as if stock market investors have suddenly decided to jump on small-cap stocks because of further Treasury bond buying. Investors may be buying large-cap dividend paying stocks because they can’t get enough income to beat the rate of inflation; but small-cap stocks have been going up on their own fundamentals, and it’s especially due to their valuations.
There have been some spectacular stock market performances recently from the Russell 2000 component companies, and many are still trading for very reasonable valuations. These companies include: Eagle Materials Inc. (NYSE/EXP), Pharmacyclics, Inc. (NASDAQ/PCYC), athenaHealth, Inc. (NASDAQ/ATHN), Alaska Air Group, Inc. (NYSE/ALK), Brunswick Corporation (NYSE/BC), and Axiall Corporation (NYSE/AXLL), to name a few. Many of the small-cap stocks listed on the index are actually related to the housing industry.
The Dow Jones Industrials have now hit an all-time record high, and the rest of the stock market is right behind them. The S&P 500 is about three percent from its record high. All this, with weak or no GDP growth expected in the first quarter of 2013, spending austerity, and sovereign debt crises. (See “New Record Highs for Dow Jones Transports and Russell 2000 a Very Positive Signal.”) Without question, the Federal Reserve-induced stock market strength is absolutely real among small-cap stocks and blue chips. But sustainability is the critical point, and that’s the $64,000 question.
Which is why so many individual investors are skeptical of the stock market’s recent performance. Because valuations are relatively fair, given current earnings and earnings outlooks this year, the case can be made for all stock market eventualities: to keep advancing, stay flat, or retreat in correction. I don’t know where the broader stock market is going to go, but I think that we need more leadership from the technology sector and further strength in small-cap stocks in order to get this market to move higher.
First-quarter earnings season is the catalyst. With the stock market’s strong performance in the first two months of the year, I’d say it’s more likely share prices will keep ticking higher over the near term. However, according to FactSet, earnings expectations for the first quarter of 2013 have flattened right out. They’ve been increasing for the bottom half of the year and fiscal 2014, but it’s still too early for those expectations to be believable.
Consumer staples were the strongest sector of the stock market in February. And while many small-cap stocks recently hit new highs, buying in large-cap consumer staples says that investors aren’t willing to bet on a new bull market. I wouldn’t either, given current fundamentals. A full-blown correction is right around the corner.