The Small-Cap Rally Mystery

Small caps have had a good year so far, but the reasons investors favor this asset class may not explain its outperformance, according to a recent article in The Wall Street Journal.

This year’s gains, the article says, are due to the fact that small caps are more domestically-focused and are therefore enjoying more of a benefit from the corporate tax cut than their larger peers. They are also poised to benefit from the recent pickup in the U.S. dollar.

But the article points out that there are other factors at play. “For one,” it argues, “some of the biggest stocks weighing on the S&P 500—Walmart, AT&T, Comcast and Wells Fargo—are mostly domestically focused companies, meaning they should be getting the same bounce as small caps. But they are all being hit by company- or industry-specific issues.”

The composition of the indexes should also be considered, the article points out, noting the example of healthcare stocks which are up less than 1% in the S&P 500 but up 27% in the biotech-heavy S&P 600. The S&P 500 index, it explains, is dominated by major pharmaceutical companies, which are challenged by lackluster growth (and on the prowl for biotech acquisitions).

The article concludes that small-cap stocks didn’t rally as much as big companies last year in anticipation of the tax cuts and that, “investors who worry they missed out on the small-cap rally might find they still have time.”