The last few weeks have witnessed a hardly-precedented move in micro-, small- and mid-cap indices, but specifically small- and microcaps. A look at the SP400 (MDY, MidCap ETF), the Russell-2000 (RUT, SmallCaps) or the IWC (Russel MicroCap ETF) will confirm the same, with microcaps threatening to rise from bear-market territory (127.7$ level) like Lazarus.
The move was ludicrously powerful – the Russell had a five day streak of >1% gains in a six day rally, with one of the daily moves exceeding 5%. All in all we saw a 15.2% rally over six trading days – a 3 sigma (99.3 percentile!!) move. Over these days, the ratio of small-to-large-cap returns (IWM/SPY) jumped by 11.65% — the stuff of legends and seen only about 1-2x per century. In fact, no US index ETFs in history has ever been as overbought as the Russell was recently.
Typically, rotation of liquidity into these smaller cap segments makes a market broader – rally participation and long-only opportunity rise in lockstep. The question here is whether this “rotation” has legs, whether the move is sustainable and will bring about a change in this extremely selective and mega-cap heavy rally with which we’ve all been dragged along since 2023.
This week will potentially shine a light on shifts in monetary policy, with the mid-week FOMC press conference perhaps greenlighting rate cuts after the consensus-beating CPI print a few weeks ago ignited upmarking of smaller-business EPS estimates and started the Russell rally. Easing cycles usually drive small- & mid-caps to outperform the more risk-off large-cap segments of the market, this however is a longer-term picture. As well, rate cuts typically start a sell-off broadly across equities in an immediate setting, something which would be confirmed by the yield curve which looks to un-invert after over a year of inversion since 2023, with the spread of 10-year- over 2-year money being negative since July 2022.
Whether a rate cut will happen this week or in September (consensus) though doesn’t really matter to the economic inevitabilities that are unfolding – unemployment rate (up 11% in Q2) and claims are rising, construction demand/sales have been falling due to the financing environment, “real-economy” businesses report contraction across the board, while GDP has most likely only been kept afloat by the ridiculous federal budget deficit. Corporate credit spreads do not yet herald stress in the financial system, but overall there is few reason to believe that money will now be pressure-pumped into risk assets.
In short, though there is some fresh strength in Financials, REITs and other groups, as of now the rally in the Russel and consorts (especially judging the violence of the move) promises to be nothing more than a short-covering rally after the 2022 sell-off, from which small- & microcaps never truly recovered.
Of course, only the market will tell what is and what isn’t – stay vigilant, don’t fight the trend, and make sure to trade both sides of the market.
