The Small-Cap "Bloodbath" That Never Happened

U.S. stocks are higher on Wednesday morning, with the benchmark S&P 500 and the narrower Dow Jones Industrial Average (DJINDICES: ^DJI  ) up 0.4% and 0.34%, respectively, at 10:20 a.m. EDT.

Every once in a while, it's worth calling out the financial media for an egregious error. Today I'm calling out Yahoo! Finance for this fresh headline: "Thursday's Playbook: What to watch after yesterday's small-cap bloodbath." That invitation has been sitting at the top of the Yahoo! Finance homepage since yesterday evening. It's extraordinarily misleading.

I follow the financial markets quite closely, so I was surprised to learn that a "small-cap bloodbath" had taken place without my noticing. How could this happen? I went looking for the aftermath of this bloodbath, but it was nowhere to be found: The most widely followed index of small-capitalization stocks, the Russell 2000, actually closed just a bit higher (0.05%) on Wednesday.

So what were the folks at Yahoo! Finance referring to? Here's the pertinent section in the article:

High flying momentum names had a rough Wednesday but the broader market shrugged it off. Will the weakness seep into other sectors? Maybe says Yahoo Finance senior columnist Mike Santoli:

"We've seen these divergences building in the market where you have the bigger stable old economy and even old tech stocks holding up really well, the absolute indexes not far from their all-time highs and under the surface you have lots of stocks getting smacked, lots of stocks down 20%, the small cap index breaking it's 200-day moving average."

A couple of remarks:

  • The focus of the article seems to have quickly shifted from small caps to "high flying momentum names." It's true that some high-profile names belonging to the latter group, including Twitter and Tesla Motors, "had a rough Wednesday" -- I mentioned this here -- but that group isn't identical to small-cap stocks.
  • On Tuesday, the Russell 2000 Index closed below its 200-day moving average for the first time since November 2012, but even that 1.6% decline could hardly be described as a "bloodbath." Yesterday's closing price was also below the index's 200-day moving average.

Here are two things that are true regarding small-cap stocks:

  • They have already suffered a mini-correction of sorts this year: As of Wednesday's close, the Russell 2000 was 8.7% below the 52-week high it established in March.
  • Small-cap stocks look vulnerable to further losses or an extended period of stagnation following what has been an extraordinary run: during the five-year period to April 30, the Russell 2000 produced an annualized total return of 19.8%. At a trailing price-to-earnings ratio of almost 29 (as of April 30), the iShares Russell 2000 ETF (NYSEMKT: IWM  ) looks quite expensive. At the end of the first quarter, asset manager GMO rated small-cap U.S. stocks as the worst among six different broad equity asset classes in terms of their seven-year return forecast, with a (5%) annualized total return (after inflation).

In other words, while no bloodbath has occurred, it's worth keeping an eye on small-cap stocks (and high-flying momentum names).

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Alex Dumortier

Alex Dumortier covers daily market activity from a contrarian, value-oriented perspective. He has been writing for the Motley Fool since 2006.

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