At a Glance
- The small cap index has seen several records, and is up nearly 50% in the last year
- Russell futures a "great fit" for retail traders
Good things are said to come in small packages, and that is an adage increasingly embraced by market participants as they cast about for opportunities, especially now that all the big stuff looks overbought.
With the likes of Alphabet, Apple and Amazon trading at lofty valuations, small cap stocks, indexes, and futures, are bringing back some edge to the market. A clear indication of all this is the strength in the Russell 2000 Index, which surged into record territory for multiple days in the third week of July.
Tom Goodwin, senior research director at FTSE Russell, says that small caps led the rally in stocks after Donald Trump won the White House last year, mainly on expectations of tax cuts, deregulation, and infrastructure spending. In the first half of this year, however, momentum in small caps wavered, reflecting concerns that President Trump’s legislative agenda was stalled.
Goodwin noted that the Russell 2000 Index was up 46.5 percent in the first 332 trading days since the 2016 trough.
“On the one hand, there is evidence that the Trump Trade has already partially or completely reversed. On the other hand, there is evidence that the small cap market has been buoyed up by being somewhere in the middle of a typical bull market cycle, independent of whatever is emanating from Washington, D.C.”
Investing in the relative small fry — companies with market capitalization of between $300 million to $2 billion — can have its rewards. According to the consulting firm Ibbotson Associates, the value of small cap companies rose by an average of more than 12 percent per year between 1927 and 2007. In contrast, large capitalization firms rose only 10 percent during that same period.
Trading in small caps is typically seen as the preserve of the small retail trader. But in July positioning by hedge funds in the Russell 2000 index e-mini futures “went from the most bearish in six years to the most bullish in four months,” according to a Bloomberg report.
The move into small caps is the biggest about-face on records dating back to 1994, according to data from the Commodity Futures Trading Commission, as reported by Bloomberg.
Opportunity in Small Caps
But Morad Askar, a professional trader in Chicago and known online as FuturesTrader71, says traders gain much from the Russell 2000 suite of products.
“To me, small caps present more volatility, and that’s what’s beautiful about the Russell,” Askar said in an interview with OpenMarkets. “It is quite volatile, even when the S&P and the Nasdaq are sideways, the Russell is doing something because it’s comprised of a large universe of stocks.”
Erin Gibbs, Portfolio Manager at S&P Global Market Intelligence, said investors are still hesitant toward small caps, but could be enticed by future earnings growth.
“We’d actually expect investors to take on more risk going forward, and perhaps take on a little more growth in that small-cap arena,” Gibbs told CNBC in a recent interview.
Steven DeSantis, the SMID-Cap Strategist at Jefferies, is not optimistic the bull run will continue in the $1.56 trillion small cap market because market valuations are too high and earnings growth is too weak. He also said the legislative stalemate in Washington is not helping.
“It doesn’t look like any of the policy changes are going to get done, including tax reform,” DeSantis said. “So, we are looking for a very minimal upside for the entire year and we’ve already overshot that target.”
Russell Futures Move House
CME Group announced in April of this year that the Russell 2000 suite of futures and options would return to the exchange on July 10. CME touted the move as a way for traders to access major equity indexes on a single, cost-effective platform.
“Offering the Russell 2000 Index at CME Group to trade alongside our suite of equity index benchmarks provides our customers greater capital and risk management efficiencies,” says Tim McCourt, CME Group’s Global Head of Equity Products.
Through the first three weeks, trading volume in Russell 2000 futures snowballed, reaching more than 23,000 contracts traded on July 27.
With the Russell suite back at CME, some market participants express optimism that retail trade in futures will continue to grow.
“We’ve been working to disprove the perception that futures are not a retail product,” says J.B. Mackenzie, Managing Director of Futures and Forex at TD Ameritrade. “As with any investment product, with more education, we have seen our retail customer interest in futures increase.”
Mackenzie says the Russell can be a “great fit” for retail traders because there are only a limited number of products that give exposure to the small cap universe. “And that’s where the Russell can be very attractive to retail traders. Bringing that into the suite of index products could be a great long-term product for CME.”
Askar also likes the idea of “fungibility” of the Russell 2000 — where trading correlated products allow certain advantages in margin requirements. “That’s the one big thing that the Russell brings: now you can actually trade it against the S&P, the Nasdaq, the S&P Mid Cap and the Dow and so on,” says Askar.
For many investors, investing in small cap indexes and futures is a way to invest in the United States because, unlike the big, global corporations, the fortunes of smaller companies are tied to the domestic economy.
And by investing in small cap futures, investors gain 24-hour market access. “The news cycle doesn’t end when the equity markets close,” says Mackenzie at TD Ameritrade. “And we’ve become such a flat world that the ability to disseminate information has now become real-time with mobile devices and information pushed to you.”