Small-cap stocks have taken a particularly strong beating over the past month, according to a recent article in The Wall Street Journal.
“Companies in the small-cap category, which typically have a market value of about $2 billion or less, tend to be more sensitive to economic downturns than their larger peers,” the article explains, adding, “the growing fears of economic disruption caused by the coronavirus pandemic hit when small-caps already showed potential vulnerabilities.”
The resulting downturn in this asset class has been severe, with the Russell 2000 reportedly on track for its worst month since October 1987. The article quotes Westwood Holdings senior portfolio manager Bill Costello, who said, “They’ve been eviscerated. I can’t imagine the carnage. This has just been so fast and so violent.”
The article notes the following contributing factors:
- Earnings: Small caps “don’t generate earnings to begin with,” the article explains, citing data from BofA Global Research and FactSet showing that the percentage of unprofitable companies in the Russell 2000 rose to 29% by the end of November (up from 19% in August of 2012) and remained there as of February 29th of this year.
- Debt: Small caps went into the downturn with elevated levels of debt, the article notes: “As efforts to contain the pandemic lead to a swift drop in revenue for many companies, those debt obligations could become more difficult to meet, potentially threatening some companies’ ability to stay in business.”
- Liquidity: Small-cap stocks are “typically more difficult to trade than their large-cap peers,” the article says, citing data from Goldman Sachs showing that highly liquid stocks have outperformed stocks with low liquidity. Goldman analysts expect the trend to continue until the S&P 500 hits it near-term low.
