WHAT STOCKS ARE DRIVING THIS RALLY?
After a brief retreat, stocks have powered ahead in 2021. The S&P 500 is up 1.61% YTD, but more impressively, it is up 2.79% in the past 3 days. The real winners, however, are small-cap stocks. The Russell 2000 Index is up 7.76% in the past 3 days (table below). In this report, TPA examines the nature of this first-week rally of 2021 and tries to identify the nature of what is really rising.
One factor driving stocks is rising rates.
The U.S. 10-year Yield is 1.087% up from 0.919% at the end of 2020. That is an 18% rally in just 4 days. In the recent 1/4/21 and earlier 8/4/20 World Snapshots, TPA explained what to buy in rising rate environments. The big winner in the past 8 rising rate environments since 1995 has been small-cap stocks, and they are not disappointing so far this year (table at the bottom of this report).
Drilling down, TPA raises a red flag in all this euphoria.
The table below shows data for the Russell 3000 stocks. TPA ranked all Russell 3000 stocks by their 3-day performance and then broke them down into 5 percentiles; top 20% to bottom 20% by 3-day performance. The top 20% of stock's average 3-day performance was +16.95%; more than twice the average for all stocks.
Market Cap
The next column confirms TPA’s analysis that small-cap stocks have been the outperformers as rates have moved higher. The top 20% of the performance ranked stocks had an average market cap of $4.06 billion, while the bottom 20% had an average market cap of $34.4 billion.
Free Cashflow Per Share
Since many of the stocks have no earnings, PE’s are tough to compare. Instead, TPA measured Free Cashflow per share. Note that the best performing 20% of stocks in the past 3 days have almost ½ the Free Cashflow Per Share as the average stock in the Russell 3000.
Return on Equity
ROE is also telling. The top 20% of stocks by 3-day performance have a ROE of -18.32. This is not only alarming, it is also more than 3 times lower than the average stock in the Russell 3000.
TPA expected small-cap stocks to do well as rates rose, but the quality of the best-performing stocks should give clients pause. The best-performing stocks in terms of price look to be weak fundamentally. This means that expectations are high and that any disappointment could spell trouble for the leaders and, most likely, the market as a whole.
