Small cap stocks are starting to have their day in the sun. The Russell 200 has started to catch up to large cap indexes this autumn, and some stocks look ready to surge. The index is now up 21.2% for the year, just a few points behind the S&P 500’s 25.5%. According to Merrill Lynch, economic recoveries “tend to be the best phase for small-caps …That’s one key reason we think we could be poised for a shift from large to small”. According to a Jefferies analyst, “I think small is primed to outperform as the economy and earnings improve in 2020 … That’s going to be the whole ballgame”.
FINSUM: It is hard to imagine the US is going to enter an “economic recovery phase” at the end of a ten-year bull run, but the market’s perception of the current economy is exactly that, so these forecasts might be spot on.
Goldman put out a warning on Friday and advisors should pay attention. The bank is warning of what it calls a “baby” bear market. The focus this time is not on equities but on bonds, which have mostly been very hot this year. Goldman thinks that Treasury yields are going to take a hit in 2020, falling back to around 2.25% on the ten-year. That is a pretty large move from the 1.7% level seen today. The catch on Goldman’s call is that it doesn’t really see the move beginning until the second half of 2020, so it is a bit of a delayed bet.
FINSUM: This is quite a long-term view and in Goldman’s own words is contingent upon investors thinking the Fed might hike rates. That seems a LONG way off; at least post-2020 election we would think.
After what was a great run for much of this year, ETFs investors are fleeing bonds. After yields fell sharply for most of 2019, investors have been stung this month as yields have shot higher. Ten-year Treasuries have gone from 1.7% to 1.9% yields, causing over half of all bonds to lose value. Investors have been pulling billions out of funds as a result. The iShares 20-year Treasury ETF has lost 7.8% since August 28th. One of the areas that has been more durable is high yield, where average prices have risen a little over 1% in the same time frame.
FINSUM: Bonds losing is a sign that investors are getting less worried about a recession, which in our view is an optimistic sign.
Bank of America has just made a bold call on the direction of yields. The bank has sharply increased its forecasts for where bond yields will be at the end of the year. Its previous forecast for the ten-year was 1.25%, but it has just moved that up to 2%. It made similar adjustments to its forecast for German and British bonds. “Relative to our more pessimistic revision in August, the US and China are working to de-escalate trade tensions, no-deal Brexit risks have been banished for now, global data have started to stabilize, and central banks have shifted from dovish to neutral policy stances”.
FINSUM: Based on the change in mood amongst investors and central banks, this forecasted change makes total sense to us.
Any small cap investor can tell you that the end of the year is not usually a good time. Small caps historically suffer in November and December compared to the rest of the year. However, 2019 looks to be shaping up differently according to the Wall Street Journal. The reason small caps are usually weak at the end of the year is that managers sell off their holdings and mirror the market at the year-end as a way of insulating their annual bonus (which is based on outperformance). However, in years where overall stock performance has been strong, this pattern is less obvious. So, given 2019’s strong gains, it seems like small caps probably won’t suffer so much.
FINSUM: This is by no means a guarantee, but it certainly seems like a more positive structural consideration.
For many months there has been a great deal of fear about the threat of BBB bonds falling into the “junk” category. The whole fear is based on the idea that as the economy slows, this huge group of companies would get downgraded and there would be forced divestiture, sending bond prices strongly lower. However, the opposite has happened. Over the last few months, BBB bonds done nothing but strengthen. In fact, the spread between BBBs and Treasuries just hit a 52-week low, showing investors renewed faith in what is the largest segment of corporate bonds.
FINSUM: Unsurprisingly, the price growth has led to a bunch of new issuance. It is important to remember that though prices have risen, the risk of a recession and downgrades is still very much there.