Will the S&P 500 outperform the Russell 2000 under rising rates?


Nov. 26 2019, Updated 4:23 p.m. ET

Will the Russell 2000 feel a small cap pinch?

Should interest rates begin rising as a result of a progressive Fed taper, post-2008 investment returns based on index-specific allocation could see major changes. In other words, growth could begin to slow relative to value, and small caps could slow relative to large caps. The below graph captures the same data as the graph in the prior article, though it illustrates the total return data on a year-over-year basis as opposed to a cumulative basis. This graph reflects the history of the S&P 400 mid cap index holding up better than the other indices after the Dot Com collapse, as well as in other declining market environments. Over time, this has led to a significant outperformance of the S&P 400 mid cap index over other indices, as we noted in the prior graph in this series.

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However, since 2011, the broader Russell 2000 (the blue line) has outperformed both the S&P 500 and S&P 400 on a total return basis by nearly 10%. This article considers the outperformance of the S&P 400 Mid Cap total return index over its peers in terms of market risk, while the next two articles consider company size and value versus growth as major factors affecting portfolio return. Given the changes in the interest rate environment, investors will need to focus on which market sectors provide the best risk-to-reward profile, based on their appetite for risk.

For an overview on these risk factors, please see the prior series The 4 most important factors of the Fed taper for your portfolio.

Avoiding the lows

The above graph reflects the outperformance of the S&P 400 Mid Cap index since 1998. As the graph in the prior article made clear, over time, the S&P 400 Mid Cap total return index has outperformed, as it hasn’t fallen as far as other indices—and given constant growth rates moving forward, this has translated into a higher total return over time. While the S&P 400 total return index fell like everything else in 2008, it’s possible that this was somewhat of an anomaly, as this index outperformed all others in the recovery, putting it back in the lead in terms of total returns to date once again.

To see how the allocation to value shares across small mid and large indices has performed over time, please see the next article in this series.

Equity outlook: Constructive macro view

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Despite problems in Ukraine and China, and despite the modest consumption data in the USA, U.S. labor markets appear to be well into recovery—with the exception of the long-term unemployed. From this perspective, it would appear that the U.S. is probably the most attractive major investment market at the moment. While the fixed investment environment of the U.S. is still quite poor,  and household net worth have hit record levels. Hopefully, all of this wealth and liquidity can find their way into a new wave of profitable investment opportunities and significantly augment the improvement in the current economic recovery. For investors who see a virtuous cycle of employment, consumption and investment in the works, the continued outperformance of growth stocks over value stocks could remain the prevailing trend, favoring the iShares Russell 1000 Growth Index (IWF) and growth-oriented companies such as Google (GOOG) or Apple (AAPL).

Equity outlook: Cautious macro view

Given the China- and Russia-related uncertainties, investors may wish to consider limiting excessive exposure to broad equity markets, as reflected in the iShares Russell 2000 Index (IWM), the State Street Global Advisors S&P 500 SPDR (SPY), the Dow Jones SPDRs (DIA), and the iShares S&P 500 (IVV). Accordingly, investors may wish to consider shifting equity exposure to more defensive consumer staples–related shares, as reflected in the iShares Russell 1000 Value Index (IWD), such as Walmart (WMT).


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