What Happens to Small Caps After a Huge Monthly Gain?

The Russell 2000 Index of small cap stocks is currently on pace for its best month ever.

As of Tuesday afternoon, it’s now up more than 20% for the month of November.

The Russell 2000 dates back to 1979.

The best month ever was in February of 2000 when it rose 16.5%. The ensuing returns following that huge gain weren’t great. Over the next year, the Russell was down nearly 17%. Over the following three years small caps fell 35% in the aftermath of the dot-com bubble deflating, the 2001 recession and 9/11.

Despite the poor returns following that big up month, historically small cap stocks have done pretty well following large monthly gains.

I looked at every double-digit return month for the Russell 2000 going back to 1979 and then calculated the total returns for the ensuing 1, 3 and 5 year periods to see how they performed after those wonderful months:

Returns were higher in 12 out of 16 one year periods following a double-digit return with an average return of more than 15%. Three-year returns were positive 13 out of 15 years while there has never been a negative return five years after such a large monthly gain. The average total returns over three and five years were 45% and 80%, respectively.

So the worst-case scenario was a brutal bear market following a melt-up while the averages show fairly strong returns the majority of the time.

There will always be performance chasers who jump on the momentum bandwagon when they see a move like this but there are also those investors who always assume they missed the boat when these types of large spikes occur.

It’s perfectly normal for stocks to continue going up even after they experience a huge jump in price. It’s not guaranteed but you’re also not guaranteed to see a nasty crash just because stocks show large gains in the short-term.

When stocks are falling it always feels like you’re going to buy too early. And when stocks are rising it always feels like you’re going to buy too late. So it goes.

It’s also worth pointing out that we can put to bed the narrative that it’s only a handful of stocks propping up the U.S. stock market this year.

Yes, the large tech stocks still have some of the best returns in 2020 but this magical run in November for small caps has closed the gap in a hurry between the Russell 2000 and the S&P 500. As of September 30th, the S&P 500 was up roughly 5.5% on the year while the Russell 2000 was down almost 9% in 2020.

Now look at how close the returns are:

From the bottom on March 23, the S&P 500 is up an impressive 64%. But the Russell 2000 is now up more than 87% from the bottom.

Nothing is promised from here but the stock market seems to be going through a sea change at the moment.

Further Reading:
What Happened to Small Cap Value?

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

The Compound Media, Inc., an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here: https://www.ritholtzwealth.com/advertising-disclaimers

Please see disclosures here.