Revenge of the Small Caps

By: Spencer Israel

For most of the last decade, mega-cap tech stocks got all the love from investors. 

This FAANGM group—which colloquially includes Facebook, Alphabet, Amazon, Apple, Microsoft, and Netflix—dominated the market so thoroughly that it brought about comparisons to the dot-com bubble.

Just look at this chart from Yardeni Research, which shows how this group of six stocks performed compared to the other 494 stocks in the S&P 500 going back to 2013. 

Source: Yardeni Research

But while it’s true that the FAANGM group has only gotten bigger since the pandemic began, they’ve been upstaged by another group: small cap stocks. 

Look at a chart of the recent performance of the iShares Russell 2000 ETF (IWM) compared to its large-cap counterparts. Since the beginning of November, the IWM has more than doubled the performance of the SPDR S&P 500 ETF (SPY) and SPDR Dow Jones Industrial Average ETF (DIA) (and very nearly doubled the Invesco Nasdaq 100 ETF (QQQ)).

Source: Benzinga Pro*

Since the new year, the divergence has only become more pronounced, as the IWM has risen 17% compared to 8% for the QQQ, 6% for the SPY, and 4% for the DIA. The FAANGM stocks, meanwhile, have risen just 5.8%.*

Some people observing this rotation are surely saying “It’s about time!” Others are probably wondering why the same stocks that carried the market higher for a decade are suddenly out of favor. 

The answer to that question, of course, depends on who you ask. 

Maybe it’s economical. It’s been noted that small caps have historically outperformed following recessions, which could mean the group will continue to outperform deeper into 2021. Others have attributed it to the Biden Administration

Maybe the shift is fundamental. Many of these stocks, after all, are cheaper than their large-cap peers. Raymond James strategist Tavis McCourt pointed out that the S&P 500 is trading at a forward price-to-earnings ratio of 22.5 compared to just 14 for the Russell 2000.

You could even blame social media for part of it. Many “meme stocks” like GameStop, AMC Entertainment, and Bed Bath & Beyond are all members of the Russell 2000. 

Then again, maybe the reason for this rotation doesn’t matter. What does matter is it’s happening. For the trend followers among us, it means it’s time to go overweight small cap stocks. For the contrarians, it may be time to consider buying mega-cap tech. 

That sentence would have been unthinkable a year ago. 

*Data as of Feb. 14, 2021
The author is long the S&P 500 in his retirement accounts.

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