The conventional wisdom on the stock of smaller companies or small-cap stocks is that they produce higher returns over the long run because they are more risky than large-cap companies. After all, the risk-return ratio seems to justify that, doesn’t it?
If that relationship starts to break down, it suggests problems for the overall stock market. Take a look at this graph, which tracks the Russell 2000 Index of smaller companies:
Since the crash of 2008/9, small-caps have trended upwards within an increasingly narrow band. Breaking out of that band is a worrisome sign, and it has now broken out!
It seems counter-intuitive that small-caps, which have minimal international trade, would be breaking out of its long-term trend while large-caps, which have 50% sales exposure to international trade, are not breaking out, especially during this period when the U.S. economy is largely out-performing the rest of the world. That is even more worrisome.
This is probably just a technical breakout and not a panic button, but it is worth watching . . .
