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IF YOU HAVE LOADED UP ON SMALL CAPS, BE CAREFUL HERE.

IF YOU HAVE LOADED UP ON SMALL CAPS, BE CAREFUL HERE.


TPA told clients to buy Small Caps in October 2020 and January 2021. In February, after a huge Small Cap rally, TPA said it was time to be cautious on Small Caps. Today, TPA is telling clients that if rates do not stop their decline, the time for Small Caps will be near an end.


In the 10/26/20 World Snapshot entitled “WHAT OUTPERFORMS WHEN RATES RISE”, TPA told clients that rates had bottomed on 8/2/21 and to buy Small Caps. TPA’s reasoning was based on studying what had occurred in periods of rising interest rates since 1998. In 6 periods since 1998 when rates were up an average of 73%, the best performing broad category is Small Caps. In those 6 periods, the Russell 2000 was up 29% on average, while the Russell 1000 was up only 23% on average. Since TPA’s recommendation on 10/26/20, Small Caps are up 37% and Large Caps are up only 21%.


TPA reiterated its positive Small Cap stance on 1/4/21 in the report entitled “WHAT TO BUY IN A RISING RATE ENVIRONMENT”. By Mid-February 2021, Small Caps had become historically extended. In the World Snapshot “SMALL CAPS ARE STATISTICALLY OUT OF WHACK COMPARED TO LARGE CAPS”, TPA explained:

“The 3 charts & tables below show the historical spread analysis for the Russell 1000 versus the Russell 2000. Table 1 examines a 1-year time period and shows that the spread is now 2.68 standard deviations away from the mean. Tables 2 and 3 show the 5-year and 10-year time periods in which the historic spread is 4.69 and 5.49 standard deviations away from the period mean, respectively.”


Chart 1 shows that the U.S. 10-year bottomed on 8/2/20 and then rallied 250% in just 9 months. Rates seem to have peaked in March and are now declining. The relative performance chart 2 shows the huge outperformance of Small Caps from the U.S. 10-Year nadir on 8/2/20 and especially after TPA’s recommendation in October 2020. The red highlighted area shows what has happened since rates peaked in March. Chart 3 shows that since mid-March, the 10 year is down from 1.73% to 1.59% and, in that timeframe, Small Caps are down 1.8%, while the S&P500 is up 6.7%.


If rates can regain a foothold, the large recent underperformance of Small Caps may abate, but if they cannot rally, Small Caps may be a crowded uncomfortable spot for many money managers.


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