The economy and stock market are wading through a lot of uncertainty and volatility right now concerning the coronavirus, but one telling signal within small-cap stocks could be a bad omen of things to come.
It’s no secret the COVID-19 lockdown has absolutely obliterated the sentiment of many small businesses around the U.S., and looking more closely at the stock market shows that investor sentiment toward small-cap stocks has shifted as well.
The U.S. economy is a wreck since efforts to stop the spread of the virus forced many businesses to close or drastically reduce output. A Department of Labor report released Friday shows 20.5 million nonfarm jobs were lost in April, sending unemployment soaring to 14.7%.
A recent survey of small businesses from CNBC and SurveyMonkey showed that only 18% of owners polled call their current business conditions “good,” which was a huge drop from the 56% reported in the first quarter of 2020.
But the stock market is rallying despite the terrible economic numbers, so what’s going on?
What Small-Cap Stocks Could Be Signalling
While investors pile into companies with huge market capitalizations, pushing indexes off recent March lows, small-cap stocks have actually lagged the rally. Check out this chart:
The blue line is large-cap stock performance on the S&P 500 since the start of 2020, and the red line shows small-cap stocks. While both sectors have rallied from March 23 lows, small-cap growth is lagging by about 10%.
Banyan Hill Publishing’s Ted Bauman said this is creating an inaccurate picture of the stock market as investors flock to the larger sector instead of small-cap stocks.
“Small-cap companies tend to be those that sell goods and services either directly to consumers or to other companies,” said Bauman, an economist and editor of The Bauman Letter and Alpha Stock Alert. “With the economy on lockdown, their earnings and share prices are suffering. So investors are piling into bigger tech companies and since they have such massive market capitalization, it makes it seem as though the stock market as a whole is healthy.”
But eventually those large-cap stocks will start to feel the effects of a stalled-out economy too, Bauman warned.
“Ultimately, those companies also depend on spending in the broader economy, so eventually they too will feel the pinch,” he added.
Small-cap stocks, which Bauman calls “the heartbeat of the economy,” lagging large-cap growth was one of the six reasons stocks will plunge again he laid out in a recent YouTube video. Go here to watch the video in full, and be sure to subscribe to get Bauman’s latest insights into the stock market and economy.
While there are some signs pointing to the stock market heading down again soon, Bauman still sees opportunity in the certain companies.
“Right now, I’m focusing on companies that pay dividends, that are backed by solid, real-world assets like real estate, and operate in industries that are relatively immune from the virus,” Bauman said.
Small-cap stocks could be in for more pain as the U.S. tries to get its economy rolling again. Are they signalling a greater impact on the economy and markets ahead?
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