Updated Wednesday, April 23, 2014 as of 6:13 PM ET
Portfolio - Investment Insights
Small-Caps Double Dow in 34-Year Sign Economy Gaining Speed
by: BLOOMBERG NEWS
Monday, October 28, 2013
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The smallest stocks are rallying almost twice as fast as bigger companies in the U.S., a bullish economic signal from businesses whose profits are most dependent on domestic demand.

Shares of companies from Rite Aid Corp. to Teledyne Technologies Inc. in the Russell 2000 Index have advanced 32% in 2013, compared with 19% for the Dow Jones Industrial Average. The spread is the widest for any year since 2003, according to data compiled by Bloomberg. Three of the last four times small-caps outperformed by this much, the economy grew faster the next year and stocks stayed in a bull market for another year or more, based on data from the past 34 years.

Gains in smaller companies that are more dependent on U.S. growth show investors are betting the world’s largest economy will pick up even after jobs growth slowed and the government shutdown weighed on gross domestic product. Smaller firms are surpassing analyst earnings estimates by more than Dow companies and are forecast to grow faster next year.

“If you’re focused on the U.S., and the U.S. is performing very well, then of course your revenues and earnings are going to be much better,” Kully Samra of Charles Schwab Corp., which has $2.15 trillion of assets globally, said by phone Oct. 24 from London. “Other regions are at different stages of dealing with structural issues, and the U.S. has already dealt with them.”

The average company in the Russell 2000 gets 84% of its sales from the U.S. and is valued at $972 million, compared with 55% and $152 billion for the Dow, data compiled by Bloomberg show.

THIRD GAIN

The Standard & Poor’s 500 Index climbed 0.9% last week to 1,759.77, its third straight advance, after a weaker- than-forecast jobs report spurred speculation the Federal Reserve will maintain stimulus. More than $2.3 billion went into exchange-traded funds that invest in U.S. equities Oct. 21 through Oct. 24. The iShares Russell 2000 ETF attracted almost $500 million, the second-most among about 500 funds, according to Bloomberg data. Futures on the S&P 500 expiring in December added 0.2% at 9:17 a.m. in London today.

Rite Aid, the third-largest U.S. drugstore chain, raised its profit forecast last month because of increasing sales at remodeled stores. The Camp Hill, Pennsylvania-based company gets 100% of its sales from the U.S. and has rallied 276% in 2013.

Teledyne Technologies, which gets 80% of its revenue from the U.S., raised its 2013 per-share earnings projections last week. The Thousand Oaks, California-based aerospace and defense electronics provider, up 39% for the year, exceeded analyst projections by 8.1% last quarter, data compiled by Bloomberg show.

ORBITZ RALLY

Orbitz Worldwide Inc. in August projected third-quarter revenue would be higher than analysts estimated. Orbitz, which gets 72% of sales from the U.S., has rallied 219% in 2013 and beaten estimates the last two quarters. The company is scheduled to report results for the third quarter on Nov. 5.

Small-caps have outperformed since the bull market began in March 2009, climbing 226%, compared with 138% for large-caps. Furniture store Pier 1 Imports Inc. and Dana Holding Corp., a maker of car and truck axles, led the Russell 2000, advancing more than 11,000% each. The biggest gainers in the Dow during the period were American Express Co. with a 676% gain and Walt Disney Co., which rose 344%.

ACCELERATING RALLY

The advance in small companies has accelerated in the last four months, with the Russell 2000 rising 14% since June 30 compared with 4.4% in the Dow industrials. The gap is the biggest for any similar period since 1997, according to data compiled by Bloomberg.

“The main driver of small-caps is the cyclicality of the market,” Patrick Moonen, who helps oversee about $240 billion as senior strategist at ING Investment Management in The Hague, said by telephone. “What are the economic prospects and how are risk aversion or risk appetite evolving? Both factors were clear tailwinds for small-caps so far this year.”

Smaller companies usually climb faster at the start of a bull market, making them a proxy for future economic activity. The Russell 2000 was up 71% in the first six months of the 2009 rally, compared with a 46% advance in the Dow. This year’s outperformance is occurring almost five years after stocks started rallying, signaling the economic recovery will accelerate from what has been slowest rate since World War II.

ECONOMIC PROJECTIONS

U.S. GDP will increase at a 2.4% annual pace this quarter and reach 3% a year from now, economist estimates compiled by Bloomberg show. This month’s budget impasse will spur Fed policy makers to wait until March to scale back the $85 billion of monthly bond purchases, a Bloomberg survey showed this month.

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