Despite the early August tumult, small-cap stocks diverged from the jubilant rise witnessed in their larger counterparts, hinting at a pause in the market rotation trend seen since July.
The Russell 2000 index, closely monitored through the iShares Russell 2000 ETF Trust (NYSE: IWM), took a notable hit at the onset of August, finding crucial support at its 200-day moving average.
Since then, the index has struggled to breach the resistance of its 50-day moving average, reflecting waning optimism.
Surprisingly, the Russell 2000 responded unfavorably to the subdued July inflation data on Wednesday, marking a 0.7% dip and underperforming its large-cap counterparts.
This sharp reaction contrasts starkly with the small-cap surge observed in July following a lower-than-expected June inflation report released on July 11.
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Bank of America analyst Jill Carey Hall highlighted that the Russell 2000 currently boasts a price-to-earnings ratio of 15.5x, slightly surpassing its historical average P/E of 15.2x.
Nevertheless, Hall emphasized that “small caps remain cheap compared to large caps,” trading at about a 25% discount to their historical average (relative P/E of 0.74 vs. the historical average of 1.0x).
Michael A. Gayed, CFA, portfolio manager at Toroso Investments, also delved into recent market dynamics.
“We’ve witnessed small caps transition from rotation boost to risk-averse asset within a month,” Gayed observed, underscoring the swift shift in market sentiment.
The initial rotation stemmed from a lower-than-expected U.S. inflation reading, coupled with positive growth prospects, fueling equity upswings.
Yet, following the lackluster July jobs report redirecting the narrative toward recession concerns, the market’s appetite for risk waned, causing small caps to once again lag behind their larger counterparts.
“If small caps continue to trail as they have been since late July, it signals heightened risk aversion and casts doubt on the current equity rebound,” Gayed added.
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