Since 1999 the small cap sector has been leading its larger cap cousins in performance. This long term trend has reasserted itself once again. Here’s a chart of the Russell 2000 divided by the S&P 500 index:
Small cap stocks were affected by the recent correction but slightly less so, falling about 5.9% peak to trough. The strong breadth that we’ve observed for some time is by a large part thanks to this portion of the stock market.
As a group, small caps are also more likely to be domestic focused companies (barring a few exceptions like the trendy Chinese IPOs we’ve seen recently). So the strength in small caps is also a vote of confidence in the US economy and its ability to birth mega-corporations.
On a relative basis, the Russell 2000 index is now performing better than the S&P 500 large cap index since 1986. This makes it difficult to argue against the bull market. The only argument against the bull market based on this outperformance may be that it is a sign of exuberance and risk seeking.
This is because large cap stocks are more diversified (either by market or geography) and perceived to be less risky. However, the level of preference for small cap stocks has been persistent. As well, I don’t think it is at a level that can be dangerous yet.
Having said that, we must note that this relative outperformance is no guarantee of a continuing bull market. In the heady days of the late 1990’s when there was a general buzz around equities and equity trading, small caps were performing horribly (in relation to large caps).
What this outperformance tells us is that the bull market is not contained within a small section of the stock market. And as long as the uptrend is supported by a wide and varied constituency, it has a much higher chance of continuing.