Small-Cap Stocks to Stay in the Wake of the Big Boys, LPL Says

While small names have done OK, they suffer from factors like a possibly weakening dollar, the firm’s John Lynch argues.

The woes of small-cap stocks continue, with no end in sight. That’s the conclusion of LPL Financial’s chief investment strategist, John Lynch.

This has been the day of the large capitalization stock, with monsters like Facebook and Apple tearing up the track. The Russell 2000, which tracks small stocks, has lagged significantly the large-cap index, the S&P 5000. Sure, the small fry stocks have done better lately, but not as well as their big brothers.

As Lynch wrote in a research note, “the Russell 2000 has struggled to notch its first record high since August 2018.” The S&P 500 has garnered 42 record highs since then.

Currency fluctuations could hurt the small names ahead, Lynch said. Usually, small caps benefit from a rising US dollar, because they get most of their revenue domestically. Then, the large caps, often with significant overseas operations, find their foreign-earned income diminishes when brought home, Lynch emphasized.

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Now, there are indications that this headwind for large caps may be going away. Lynch said the dollar shows signs of weakening, which would whittle away this small-cap advantage.

“Small caps may eventually reach that coveted record-high status, but we think it’s unlikely they’ll pull ahead meaningfully this year,” the LPL strategist wrote.

Indeed, the performance gap between the two types of stocks has widened. Over 10 years, the S&P index has posted a 14% average total return (price performance plus dividends) versus the Russell benchmark’s 12.1%. But during the recent five-year span, the S&P clocked a 12% gain, with the Russell mustering just 8.2%.

In 2018, the worst year for stocks in the past decade, the large-cap index slid only 4.5%. The Russell dropped almost three times as much, losing 11.1%. And this year, the small-cap index is down 1%, and the large-cap one is up 1.5%.

On Jan. 16, the small-cap barometer came within 2% of exceeding its all-time high, reached in mid-2018 (this happened before stocks tumbled in that year’s nasty fourth quarter). Then, amid market jitters over the coronavirus, small caps fell back. 

As Lynch put it: “Stock markets around the world have hit new record highs this year, but US small-cap stocks have yet to join the party.”

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