Buoyed by strong consumer spending, an economy that continues to grow and changes to the tax laws, shares of small-cap companies surged ahead on Wednesday as the Russell 2000 closed at 1,619.89 —a record high. It is interesting to note that investors’ enthusiasm for the relatively riskier small-cap sector occurred as the yield on the Treasury’s bellwether 10-year Note rose to 3.1% —its highest level in seven years. Normally, such a change in the yield curve would make fixed-income vehicles more competitive with stocks. To date, however, rising interest rates have not had a substantial impact on the direction of the small-cap index.
Since the beginning of the year, small companies have bested their larger multinational counterparts. The Russell 2000 is now up 5.3% for the year, outperforming the S&P 500, which has risen 1.8%, and the Dow Jones Industrial Average, which logged an increase of only 0.25%. Both large-cap indexes remain 5% below their January highs.
An environment of deregulation in conjunction with reduced tax rates have bolstered confidence in prospects for growth on the part of small business managers. Small firms tend to pay higher effective corporate tax rates than multinationals, so the benefits from a reduction in rates was particularly pronounced.
The Russell 2000 faltered somewhat last year as cautious investors shifted funds to large multinationals that they believed were better positioned to reap the benefits of a projected increase in global economic growth.
There are indications, however, that the rate of growth worldwide in both emerging as well as mature economies could be slackening. First-quarter growth in Europe appears to have slowed and data released on Tuesday indicates Japan’s economy continues to contract over the same period, ending the longest growth streak in almost 30 years.
While there are signs that overseas markets may be slowing, the U.S. economy continues to appear robust and small caps are reaping the rewards. The rally in the small-cap sector is, in part, due to the fact the fortunes of these companies are more dependent on the ebbs and flows of the domestic economy than are the multinationals.
Those investors who currently favor small caps feel confident that any changes in trade policies with China and other nations will be less likely to adversely impact the earnings of smaller companies. An examination of the composition of the Russell 2000 and the S&P 500 indexes lends credence to this proposition. Approximately 30% of the revenue generated by S&P 500 corporations is from foreign operations, in comparison to 21% for those companies that comprise the Russell 2000.
Despite an increase in gasoline prices, data from the Commerce Department released on Tuesday indicates American consumers exhibited confidence in the economy as second-quarter figures showed a notable increase in household spending.
A review of the performance of two small-cap consumer spending-sensitive companies reflects investors' current optimism in this sector.
BJ’s Restaurants Inc. (BJRI, Financial) has been one of the small companies that has reaped the benefits of consumer confidence, as evidenced by a 44% increase in its shares this year.
Jack Springer, CEO of Malibu Boats Inc. (MBUU, Financial), noted during a recent conference call with investors that consumers were more prevalent at boat shows this year, and there were more buyers than lookers. The price of Malibu’s stock has increase 47% for the year.
Disclosure: I have no interest in any of the securities referenced in this article.
