Feb 9, 2021 - Economy

Stimulus, the yield curve and reopening hopes help small-cap stocks boom

Data: FactSet; Chart: Axios Visuals

Despite the incredibly weak job market investors are betting the U.S. economy will continue to strengthen and are pouring money into small-cap stocks.

What's happening: Small companies' stocks have lagged their large counterparts for years as bigger has meant better on Wall Street. But over the past six months, that trend has reversed and investors are playing small ball.

What it means: "Small cap stocks tend to outperform as the economy improves," ADP senior economist Nela Richardson tells Axios in an email.

  • "The prospects for continued economic recovery are solid given the vaccine rollout, pent-up consumer demand, ongoing monetary stimulus and perhaps more fiscal stimulus. Hence, conditions are set for which small caps have outperformed historically, (even though the jobs recovery has cooled recently)."

The big question: "Does the rally have legs?" asks Richard Steinberg, chief market strategist of the Colony Group.

  • "As long as data show that vaccines are starting to work and there’s a policy to get more shots in people’s arms we are going to get more confidence."
  • "We’re seeing the numbers in earnings too. There’s leverage to the reopening."

Watch this space: The widening U.S. Treasury yield curve (the 5-year/30-year spread rose to 1.5% Monday, the highest since September 2015) also provides a boost for small-cap stocks because banks and financial services companies, which see their share prices rise as longer-dated bonds' yields go up, are over-represented among small-cap indexes, Steinberg adds.

  • "The yield curve and reopening and fiscal stimulus all play into small caps with a domestic focus."

But, but, but: For the bounce in small-cap stocks to continue, the market's extremely rosy expectations will have to become reality.

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