Over the last few weeks, the correction of late July/early August has been almost entirely erased.
But, as we saw in April, that’s done little to mute the chorus of voices proclaiming that the bull market is coming to an end.
My former boss, Cabot legend Tim Lutts, had an oft-repeated adage I’d like to relay to the bearish naysayers: “Stock market trends last longer than anyone expects.”
It’s worth remembering that this bull market is still quite young. Its 22-month run has just barely surpassed the shortest bull market (21 months) in history. Meanwhile, the average bull market lasts 61 months – nearly three times the length of the current one!
The same is true of bear markets, of course. The average bear market lasts 289 days, or nine and a half months. And that was almost exactly the length of the 2022 bear market, which began at the end of 2021 and lasted until mid-October of 2022 (although it dragged on even longer than that for growth stocks).
That’s not to say we won’t encounter sustained periods of underperformance. We’ve seen just that in value stocks (which have underperformed growth stocks for more than a decade) and, more recently, in small-cap stocks.
Historically, small-cap stocks outperform their large-cap brethren – in three out of every five years, according to our small-cap expert, Tyler Laundon. But not in the last five years. Since August 2019, the Russell 2000 (which tracks small caps) has trailed the S&P 500 by almost a 2-to-1 deficit, up 51.8% vs. a 97.7% gain in the large-cap index.
Given that backdrop, surely the tide had to turn eventually … right?
Are Small-Caps Finally Rallying?
Well, it seems to be turning.
Small caps caught fire in early July, rallying 11% in a week before round-tripping those gains to close out the month, culminating with the market sell-off on August 5.
But, once the dust settled, small caps picked right up where they left off, rising a quick 8.8% and once again approaching all-time highs while slightly outperforming their larger peers.
So what changed? The Fed.
OK, so the Fed didn’t change exactly. But better-than-expected inflation numbers and a weakening labor market have prompted Jerome Powell and company to signal that rate cuts are coming at the recent Jackson Hole keynote address. Could those impending rate cuts signal brighter times ahead?
Here’s my take: Small caps have merely been a microcosm of “the rest of the market” outside of the Magnificent Seven and a handful of leading artificial intelligence stocks.
Essentially, the Russell is simply the S&P 500 minus the 10 mega-cap tech stocks that have been propping it up for the last 22 months. We’ve written before about how nine of the 11 S&P sectors are undervalued despite the market being at all-time highs. The same goes for small caps. So now that the tide appears to – maybe, possibly – be shifting from the Mag. 7/AI to everything else, small caps – perhaps due to their higher upside and general history of outperformance – are again attracting investor attention.
So yes, with rate cuts now finally in sight, I believe the long-awaited small-cap rally has arrived. Thus, I’ll be on the lookout for potential small-cap additions to the Growth/Income Portfolio of my Cabot Value Investor advisory in the coming weeks. To learn their names and to find out what else I’m currently recommending in this “growth at value prices” newsletter, simply click here.
