Russell 2000’s Good Fortune May Prove to Be a Bad Omen

They may be small caps, but the stakes are hardly small potatoes.

Over the last 100 days, the Russell 2000 has outperformed its rival, the S&P SmallCap 600, by 9%, marking the widest gap since 2010, according to a DataTrek Research note to clients cited by independent financial journalist Phil Rosen. Sure, you might be asking: Who cares? Who even invests in the S&P 600? How does this matter to me? Reasonable questions, of course. Unfortunately, experts say the gap could have widespread implications and is likely yet more evidence of (you guessed it) a bubble.

Frothy The Snowman

The Russell isn’t just outperforming its small-cap peer, it’s on one of its greatest runs of all time, crossing 2,500 for the first time just a month ago. In the past six months, the index has gained roughly 17%, on par with the megacap-driven, AI-supercharged S&P 500. The S&P 600, by comparison, has risen roughly 11% in the past six months. So what sets them apart? Entrance to the Russell 2000 is determined by market cap, whereas the S&P’s small-cap index requires firms to actually turn a profit before admittance. 

Historically, the difference has separated the small-cap wheat from the chaff, so to speak, which is why some see the current deviation as overly speculative: 

• Between the 600’s launch in 1994 and April’s Liberation Day earthquake, the profit-requiring index had outperformed the Russell by roughly 580%, according to an analysis in The Wall Street Journal.
• Meanwhile, 40% of the Russell companies are unprofitable compared with 22% on the S&P 600, and the Russell’s price-to-earnings ratio is twice as high as its counterpart, Eric Cinnamond, co-founder of small-cap value specialist Palm Valley Capital Management, told the WSJ.

Spirited Debate: “The Russell 2000’s recent wide outperformance versus the S&P 600 is, historically speaking, not so much a sign that it’s time to rotate into the latter as it is a signal that animal spirits are especially elevated,” DataTrek analysts wrote in their note. Cinnamond put it a little more bluntly, telling the WSJ: “Part of the reason the Russell’s doing so well is speculation and greed.”