Read for 5 minutes (Reuters) – NEW YORK (Reuters) – Small-cap stocks are being weighed down by expectations that the US economic recovery would weaken in the second half, requiring fund managers to hunt for companies that can profit in a lower-growth environment. A Wall Street sign is shown outside the New York Stock Exchange in New York on October 28, 2013. FILE PHOTO: A Wall Street sign is seen outside the New York Stock Exchange in New York on October 28, 2013. Carlo Allegri/Reuters In each of the last four months, the Russell 2000 index, which covers smaller companies, has underperformed the S&P 500. The iShares Russell 2000 index exchange traded fund saw approximately $108 million in outflows for the week ending July 14, the third consecutive week of outflows totaling roughly $965 million and the ETF’s longest losing streak since April. Small-cap stocks have benefited from the so-called reflation trade, which saw investors gamble on banks, energy companies, and other economically sensitive sectors while reducing their holdings in US Treasuries in anticipation of a strong economic rebound. The Russell 2000 is up 11.6 percent this year, while the S&P 500 is up 16.3 percent. Some now feel the recovery is gone and the economy will weaken in the coming months, prompting a return to technology and high-growth equities, which have driven markets higher over the last decade. Yields on the benchmark 10-year Treasury note, which move in the opposite direction of prices, rose slightly on Friday but remained near their lowest levels since February. Rising inflation is likely to be transitory, according to Federal Reserve Chairman Jerome Powell, who testified before Congress earlier this week, and the US central bank will continue to support the economy, putting upward pressure on yields. “We may have passed peak inflation fears and peak growth optimism,” according to Brian Jacobsen, senior investment strategist at Wells Fargo Asset Management. Due to forecasts that the economic boom from the coronavirus recovery will be short-lived, his business has reduced its overweight on small caps and is now neutral on the asset class. According to a global survey of fund managers conducted by BofA Research, fund managers have unwound their bullish bets on small caps relative to large caps to levels last seen in October 2020, before the announcement of effective coronavirus vaccines helped fuel an outsized rally in cyclical and small-cap stocks. According to Lamar Villere, a portfolio manager at Villere & Co., low bond yields will continue to weigh on small-caps as investors seek sources of income such as dividend equities rather than capital gains. “People are chasing any yield they can get, even if it means sacrificing little caps. You’ve got a massive demand on the client side for blue chip dividend paying companies right now because they’re the only way to obtain any kind of yield “he stated He claims that his business has not taken any new small-cap investments in the last six months, instead adding companies like Viacom Inc to its portfolios. Investors will learn more about how broadly the US economy is expanding in the coming week when data on new housing starts is released on Tuesday and an index of key economic indicators is released on Thursday. Meanwhile, Netflix and Twitter are scheduled to disclose their latest quarterly earnings results this week, providing investors with a better understanding of how the economy’s reopening has affected revenue growth. Small caps should benefit from signs that rising inflation could last longer than the Fed forecasts, according to Jim Paulsen, Chief Investment Strategist at the Leuthold Group. According to Jefferies, the Russell 2000 should see a 50 percent increase in earnings in the fiscal year 2021, compared to a 44 percent increase in the large-cap S&P 500. According to Saira Malik, chief investment officer of global equities at Nuveen, the outsized growth rate and high valuations in the S&P 500 could make small caps a contrarian play for the rest of the year. She has been adding to financials in the expectation that the 10-year Treasury yield will end the year near 2%. “We absolutely think it will be tougher in the second half,” she added, “but inflation will be more stable, which will be good for small caps.” David Randall contributed reporting, while Ira Iosebashvili and Raissa Kasolowsky edited the piece./n
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