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Forget the Dow -- This Market's Record Gains Could Lead Stocks Higher in 2015

By Dan Caplinger - Dec 26, 2014 at 12:00AM

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New records in a long-lagging stock market could point to better gains ahead.

Source: Flickr user thetaxhaven.

The stock market continued to rise on Friday morning, with both the Dow Jones Industrials (^DJI 1.27%) and the S&P 500 (^GSPC 1.73%) on pace to set new record highs in a quiet post-Christmas session. Just after 12:20 p.m. EST, the Dow was up about 42 points, to 18,082, led higher by general strength across the board even while not a single stock among the index's 30 had gained more than 1% on the day. The S&P rose eight points to 2,090.

Yet as commonplace as new all-time records have become, one market got a lot of attention today. That market is the Russell 2000 (RUSSELLINDICES: ^RUT), and the small-cap index's eight-point advance to 1,214 might not immediately seem like that big a deal. Investors, though, are focusing on the Russell so much today because, unlike its larger-cap counterparts, a record close would be the small-cap benchmark's first since March. That, in turn, could reverse long-held concerns about the stock market as a whole and take away the last obstacle in a much stronger push higher for stocks in 2015.

The worry about small caps
Throughout much of 2014, investors have been nervous about the performance of small-cap stocks. During the spring, the Russell 2000 suffered much larger losses than the Dow and S&P 500 did, posting a full-blown correction of more than 10% between March and May and leading some market commentators to suggest the broader market was vulnerable to a substantial decline. Proponents of this theory noted that small-cap stocks tend to be more sensitive to changes in economic conditions than larger companies, as smaller businesses don't have the financial resources or diversified customer bases to help them withstand economic shocks that bigger stocks enjoy.

Small caps also took a hit in July, when the Federal Reserve singled out social-media and biotech companies as potentially being overvalued. With many such stocks squarely in the small-cap arena, the Russell 2000 fell more than the market as a whole.

Image source: Rafael Matsunaga, Flickr.

Then, early this fall, 2014's gains in the broader stock market came to an abrupt halt. Small caps again fell even further during the market's October swoon, raising new fears that large-cap stocks were getting ahead of themselves. At the same time, many small caps carried high valuations that led many investors to believe they were expensive, despite their lagging performance.

Defying expectations
Yet since October, the stock market has reversed its losses and marched ever higher, and small-cap stocks have this time participated in those gains. The Russell 2000 has risen 16% since its October low, and many market participants argue that those who had missed out on Wall Street's rally in 2014 have looked at small-cap stocks as a way to catch up with the performance of their larger counterparts.

Moreover, investors are more willing to look past the warning signs they heeded earlier. Although small caps have repeatedly suffered from negative momentum during the year, they traditionally have had greater sensitivity to the broader market than large caps. As a result, their recent ascent suggests better times could be ahead both for the economy and for the market as a whole.

The Russell 2000 hitting a new high would not be particularly noteworthy in its own right. But as a psychological factor that already-confident investors can add to their list of bulwarks for the market, new records for small-cap stocks could help ignite a 2015 rally that will add even more gains to 2014's solid performance.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Dow Jones Industrial Average (Price Return) Stock Quote
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