Pro Perspectives 9/27/21

September 27, 2021

We’ve talked quite a bit about the relationship between interest rates and small cap value stocks.

Specifically, when rates are rising, as a result of an economy recovering from recession, small cap value stocks tend to outperform larger cap growth.  And that outperformance, coming out of recession, has historically held for the decade forward. 

With that in mind, today the 10-year yield traded above 1.5%.  That’s nearly a quarter point higher than the levels of just two weeks ago.  And while the broader market was down today (the S&P 500), small cap stocks were up 1.7% (the Russell 2000).  

Let’s take a look at this small cap/rates relationship in a chart …

As you can see, coming out of recession, and with the catalyst of an election that telegraphed a massive fiscal spend, small caps (the orange line) aggressively followed the recovery of interest rates (the purple line) from near record low levels.  

But rates rolled over in April, and small cap value stocks have since gone sideways.

So now, we’re nine months through the year, and in a hot economic recovery, yet small cap value is underperforming the S&P 500 for the year (15.5% versus 18.3%, respectively). 

But rates are on the move again, and that’s driven by a change-in-the-direction of monetary policy (a big catalyst).

That should provide fuel for new record highs in the Russell 2000 into the end of the year, and a resumption of a very strong bull trend.     

Not surprisingly, in relationship with the rising rates picture (on both the growth and inflation picture), oil and gas stocks were the best performing sector of the day — up better than 3%. And this a key constituent of the small cap value universe.

With that in mind, oil is closing in on the seven-year highs. And the path we’ve been talking about, to $100 oil, is getting closer. As I said in my note just after the election last year, with the Biden climate agenda well telegraphed, “until we’re all driving Teslas, and the energy grid has been completely ‘green’ transformed, we will still be using a lot of oil.  We’ll just be paying a lot more for it.” 

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