Bob’s Journal
Three key factors are causing small company stocks to outperform larger company stocks in U.S. markets.
Large company stocks led the way through the early stages of this bull market, but smaller company stocks surged ahead more recently. As proof, the S&P 500 gained 8.21% for the year to date, while the small company index of the Russell 200 gained 12.67%.
Over one year, the S&P 500 gained 20.08%, compared to 28.19% for the Russell 2000. Over three years, the Russell 2000 has less of an advantage, 15.68%, compared to 15.45% for the S&P 500.
Slower growth outside of the United States is one factor. Larger companies earn more of their revenue and profits outside the United States. When overseas economies are doing well, larger companies often have higher growth rates than smaller companies.
But growth rates in most of the non-U.S. economies declined in the last year or so, while U.S. growth has remained strong and even accelerated. As a result, smaller U.S. companies have delivered higher revenue and earnings growth than larger companies.
The stronger dollar has a similar impact. When the dollar increases in value against other currencies, consumers outside the United States have to pay more in their local currencies for goods and services from U.S. companies. The U.S. companies can accept lower sales, because fewer consumers will buy their offerings. Or the U.S. companies can reduce their prices to offset the dollar’s surge. That will reduce their profit margins.
Either way, larger U.S. companies are hurt by a rising dollar. Smaller companies rarely are affected in these ways by fluctuations in the dollar, because most of their customers are based in the United States.
The trade conflicts and tariffs can damage both small and larger companies, but they tend to hurt larger companies more. The smaller companies can be hurt when inputs they need either cost more or aren’t as available. But larger companies also must deal with other countries imposing tariffs on their goods. That makes them more expensive to foreign buyers and reduces sales.
The trends that have been favoring smaller company stocks seem well-established and aren’t likely to change soon. A possible exception is the dollar’s strength. But small company stocks have done so well in the last year that their valuations are very high. Current prices for smaller companies probably already reflect a lot of the future benefits from these trends.
The Data
The economy will continue to grow for the rest of the year, according to the Index of Leading Economic Indicators from The Conference Board. The index rose 0.6%, following a 0.5% increase last month. Most of the components of the index were positive.
But the economy has lost some momentum, according to the Markit Flash PMI. The composite PMI fell to a four-month low of 55.0, down from 55.7 last month. The Services PMI component also was at a four-month low of 55.2, down from 56.0. The Manufacturing PMI was at a nine-month low of 54.3, down from 54.5. All are solid growth numbers but indicate the economy is climbing at a slower rate than a few months ago.
Consumer Sentiment, as measured by the University of Michigan, declined sharply to 95.3 from 97.9. This is the lowest level since September. The households in the bottom third of the income scale were the main factor in the decline, and their greatest concern is higher market prices for goods, especially large durable goods.
Existing home sales declined 0.7% for the month. That’s the fourth consecutive month of declining sales, and sales were at their lowest monthly level in two years. Over 12 months, sales have declined 1.5%.
New home sales also declined and were well below expectations. Sales declined 1.7% from last month but increased 12.8% over 12 months. Sales for the previous three months were revised to lower figures.
Home price increases are moderating. The FHFA House Price Index rose 0.2% for the month. That puts the 12-month increase at 6.5%, which is well above wage increases.
New unemployment claims declined another 2,000 to 210,000. That brings the four-week average down to 213,750.
The Markets
The S&P 500 rose 1.56% higher for the week ended with Wednesday’s close. The Dow Jones Industrial Average added 2.37%. The Russell 2000 bounced 3.06%. The All-Country World Index increased 2.22% and emerging market equities soared 4.26%.
Long-term treasuries returned 0.84% for the week. Investment-grade bonds rose 0.22%. Treasury Inflation-Protected Securities (TIPS) increased 0.33%, while high-yield bonds added 0.48%.
On the currency front, the dollar lost 1.68%.
Energy-based commodities rose 3.44% for the week. Broader-based commodities increased 2.07%. Gold added 1.77%.
Bob’s News & Updates
You should sign up for my Retirement Watch Spotlight Series, because I make in-depth presentations of key retirement finance topics. You can watch these online seminars from the comfort of your home or office at times you choose. To learn more about my new Spotlight Series, click here.
A recent five-star review of my book on amazon.com said, “A complete retirement guide! One of the best books on this topic!” Click for more details about the revised edition of “The New Rules of Retirement.”
I’m now a regular contributor to the Forbes.com blog. You can view my contributor page here.
Do your heirs know how to handle an inherited IRA? If not, they’ll join the long list of heirs who made simple mistakes that triggered additional taxes and penalties. To avoid this result, be sure your heirs have a copy of Bob Carlson’s Guide to Inheriting IRAs.
