US small-caps rebound as equity rally broadens

Smaller US companies have staged a stock market fightback in the past week, outperforming their larger listed peers as the equity rally broadens.

The Russell 2000 index of US small-caps posted a six-day run of positive returns up to Wednesday — its best stretch since December — sending the benchmark 15 per cent higher. That surge, driven by segments such as energy and materials, was nearly double the gain for the larger companies in the Russell 1000 index.

The stellar run shows that the growing confidence among equity investors, which has fuelled a 31 per cent rise in US blue-chips since March 23, is now lifting the smaller businesses that power much of the American economy.

The rally has nearly halved the performance gap between large-caps and small-caps that had opened up this year. Smaller companies had suffered a double-blow, falling behind during the bear market and also the recovery, as investors flocked to the safety of big businesses with solid balance sheets.

“What we’ve seen in the last few days for small-caps is an epic rally,” said John Porter, chief investment officer for Mellon Investments. “It’s chasing the optimism that we are approaching a point where we can open the economy safely . . . without worrying about the health consequences.”

Smaller companies tend to carry higher leverage and are more exposed to the domestic economy than bigger groups, making them more susceptible to dips. This, analysts say, is behind the sharper sell-off and also the reversal in fortunes as investors increase their appetite for riskier investments, in response to signs the pandemic is beginning to abate.

Support from the central bank and government has also helped. The US this week bolstered a programme to help small companies pay staff during the downturn, while the Treasury and Federal Reserve this month unveiled a $600bn lending facility aimed at boosting companies at the bigger end of the small-cap sector.

The Fed has also extended its bond-buying programme to “fallen angels” — debt from companies that have slipped from investment-grade to “junk” status. The purchases have reduced borrowing costs for businesses issuing these high-yielding bonds, which has given a lift to the smaller companies that make up a big portion of the market.

“Any help the Fed gives to high-yield is going to help small-caps,” said Max Gokhman, head of asset allocation for Pacific Life Fund Advisors. “The fact small-caps have been lagging so much means it makes sense that they would have a catch-up rally.”

Investors’ move back into cyclical stocks has boosted downbeat sectors such as energy, the top performing sector in the Russell 2000 over the past six trading days. “What you’ve seen in small-caps in the last few days is the chase for cyclicality and a reversion to the mean on steroids,” said Mr Porter.