Small Cap Value to Outperform

Macro Perspectives: Thu 22 Jul 2021

Yesterday morning, we talked about the buying opportunity in oil and oil and gas stocks.

During the day, oil was one of the biggest movers in global markets - up 4.5%, back above $70 a barrel. And energy stocks were the best performers on the day in the S&P 500, up 3.5% as a sector.

This aligns with the big outperformance of small cap value over the past two days.

As we've discussed here in my notes for the better part of last year, we should expect small caps and value to outperform large caps and growth stocks coming out of recession, and moreover, persistently outperform large caps over the next ten years.

Indeed, that has been the case. From the fourth quarter of last year, through the first quarter of this year, small cap value outperformed large cap growth by the widest margin since World War II.

Coming out of recession, small caps tend to follow the path of interest rates (climbing rates, suggests a more optimistic outlook). With that, as interest rates (the 10-year yield) rose from as low as 31 basis points last year, to as high as 1.78% this year, small cap value stocks soared. And as interest rates have rolled-over the past two months, so have small caps - creating this divergence in the chart below.

Fast forward to now: As the fear of more restrictive policies surrounding the virus variant seems to be waning, rates are bouncing, and small caps are bouncing. With that, the divergence in the chart below is beginning to close aggressively.