Mullooly Asset Management
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Recent Small Cap Action Shows Asset Allocation Key
What if a sudden surge in small cap stocks could reshape your investment strategy? Join Tim, Brendan, and Tom Mullooly on episode 482 of the Mullooly Asset Management Podcast as we navigate the recent 11.5% rise in the Russell 2000 index, a rare occurrence seen just 32 times since 1990. This episode uncovers the significance of such unexpected movements, especially amidst the stagnation of the S&P 500 and NASDAQ, and emphasizes why diversification remains crucial for a balanced portfolio. Drawing on insights from Datatrek Research and Nobel laureate Daniel Kahneman, we explore the unpredictable nature of markets and the importance of staying diversified.
As we wrap up this insightful discussion, we remind our listeners that the perspectives shared are meant to educate and inform, not dictate investment choices. The opinions expressed are personal and may not necessarily represent the views of Mullooly Asset Management. Make sure to catch our next episode for more valuable financial insights and strategies to help you navigate the ever-evolving market landscape. Stay tuned and stay informed!
Welcome back to the Malooly Asset Management Podcast. This is episode number 482. I am Tim Malooly. Here with me today is Brendan and Tom Malooly. Guys, how you doing Happy to be here, hey.
Speaker 2:so how about those small caps, huh?
Speaker 1:So we wanna talk about small caps today, and it kind of ties back to a few episodes ago or the topic of diversification in particular. Yeah, over the last week or so, small caps have had a really eye-opening run of good performance here.
Speaker 3:Tim, use the quote that you wrote in our message when we wanted to talk about this.
Speaker 1:So I said that small caps has had a really great year in the last seven days. In the last week it's true, I have the numbers.
Speaker 2:The Russell 2000 has gone up 11.5% over the last week. It's true, I have the numbers. The Russell 2000 has gone up 11.5% over the last week. That's five trading days.
Speaker 1:It's incredible.
Speaker 2:In 8,700 trading days since 1990, a move like this for the Russell 2000 has only happened 32 times, yeah, and it's a violent reversal of the trends that we've been seeing recently, in the sense that the Russell is doing this while the S&P 500 and the NASDAQ are mostly doing nothing Right basically everybody off guard or offside if they were trying to position things for the immediate future, as opposed to looking at the bigger picture and using small caps as a piece of a diversified portfolio, as we are often coaching our clients to do.
Speaker 3:It's interesting to note that you cited, however many trading days going back to 1990. One size cap you know from, say, large cap to small caps and then mid caps those kind of rotations would take 12 months. It would take us a year for these things to happen. Now they're happening much, much faster, and so it's very hard to see these things coming.
Speaker 1:Yeah, and I think it's happened before, like you pointed out. It's rare, but I remember, even just a few years ago. You know a point that we make to people when questioned about you know why do we own this, why do we own that? And there was a few years ago where small caps in particular had a really, really good fourth quarter of the year and we used that same line that I said before small caps had a great year in just in the fourth quarter. This time is even a shorter window than that just seven days, not even over the span of a quarter. Both of you have said now it's, it's something that you can't see coming. It's just a point towards diversification, like we've been talking about over the last few episodes, just consistently having exposure to these areas.
Speaker 2:Yeah, maybe a note to add to the stats I'm quoting are from Datatrack Research. Moves like this for the Russell 2000,. As rare as they are, fell into kind of like two broad buckets in terms of what else was happening during those periods, to maybe explain the movement a little bit more. And those two buckets were either bear market rallies or right after major market lows, when small caps did this over a five-day stretch, neither of which apply right now.
Speaker 1:Almost the exact opposite, honestly.
Speaker 2:And so also from Data Trek. They tacked on, just like a Wall Street adage, to this information that I think is worth sharing and they said just because something has never happened before, it doesn't mean it isn't happening right now. That, coupled with the idea that absolutely nobody was calling for this a week ago, a month ago, whatever, whatever you want to call it, is a broader point about being diversified and not needing to predict these unpredictable happenings when you are diversified, that's the important part.
Speaker 1:That is very important, but that's the point or or or to like take it another step, even just like believing whether or not this is real. You know what I mean. It's like it's never really happened before. So people are like oh, this, this can't possibly happen. Like it's not, this isn't a real move, like it's just going to revert, it's like it doesn't. You don't have to believe whether or not this is new things.
Speaker 2:This is real exactly it's it.
Speaker 2:Just because it hasn't happened before, it doesn't mean it isn't currently happening for the first time I want to share one of my favorite quotes promise last quote for the episode from, uh, daniel kahneman that I think supports our philosophy of diversification, uh, and goes hand in hand with what we're talking about. And it's that, uh, whenever we're surprised by something, even if we admit that we made a mistake, we say, oh, I'll never make that mistake again. But in fact, what you should learn from when you make a mistake because you did not anticipate something, is that the world is difficult to anticipate. That's the correct lesson to learn from surprises that the world is surprising, not specifically that, like you should have dug in deeper to find this anomaly with small caps that would have alerted you to allocate to them prior to this move?
Speaker 2:No, it's never anything as specific as that. It's that the world is surprising and you cannot predict these things, and so, of course, you make some decisions, even when you're diversifying, to pick which areas are worthwhile to allocate to over the long term. It's not that we want to own a little bit of everything because we're so ignorant. We make some choices about where we're going to allocate money for reasons that are backed up by research, historical data, and we got to give those the time to flesh out. And even an 18-month run, like we've seen with large cap beating the crap out of small caps, is to reverse the historical precedent that made us put money into small caps to begin with, and that, I think, applies to almost any area of the portfolio. It's excruciating when you've got to live through it and you do the work to make sure that you're not missing something, but most of the time you aren't. You've just got to be patient.
Speaker 1:Yeah, I think we talked about it on an episode earlier. But we get questions like why can't we just put all of our money into US large cap tech stocks and it's like? This seven-day run in small caps is a good example of why we don't do stuff like that.
Speaker 2:Yeah, and we don't know, of course, when it comes to any move like this over the short term, whether it will continue or not. But I think that if you're only allocating to what's working now, you are, by definition, always going to be chasing your own tail and I don't think that that's going to lead to very good performance over the long term. Probably feels good when you do it, because it's rewarding to just do whatever's working right now, but I don't think that that's a prudent approach over the long term when it comes to investing.
Speaker 1:Yeah, I feel like that applies. We're talking specifically about like small cap stocks here, and that's drilling down even a layer deeper than just stock bond exposure. But the same thing. We've talked about that in the past, about stocks versus bonds, just diversifying in general. It's not specific to asset class or just like high-level allocation stuff like that.
Speaker 3:It's interesting to see reading the same pieces from Datatrack, brendan, that you referenced, where they speculated that part of this may be money coming out of big tech names that are large cap that seem to overwhelm the S&P 500. Now Some money coming off the table there and going into almost like a rebalance, where they're putting money into small caps. Now that's just a speculation, you know. For the same reason, why, why is there a lot of traffic on Route 34 on Thursdays and Fridays?
Speaker 2:Or why is there a lot of traffic going north? You're trying to explain decisions that other human beings have made, which you cannot possibly do. However, it's helpful.
Speaker 3:He said it way better than I could.
Speaker 2:But it's helpful to think through the reasons why something may be occurring. It doesn't mean that you need to latch on to any individual theory and back up the truck and bet your money on it. I think it's helpful to think it through as part of a process. But you know, I actually I have a thought about what Tim was saying with diversification and this recent period of, like US large cap domination. Just thinking through diversification is never easy, but I feel like it has been even more difficult because the US large cap stock universe is like the most familiar stock market piece of the stock market, uh, that everybody knows, and so the idea that that was the area outperforming most recently. It just makes it so much more salient, I think, for people to like see the names that make up the large cap indexes and be like why don't we just own these things? And I don't think you get the same scrutiny if you're in a period where small caps or international stocks are outperforming Because nobody cares.
Speaker 1:They're companies that nobody's ever heard of, and nobody cares what European stocks are doing.
Speaker 2:That's not in their face every day, like the components of the Dow and so I'm not saying this.
Speaker 2:Even seeing the names at the bottom of the Russell 2000. It's like we don't even we hardly know the names in the small cap indexes, or at least we're not like familiar with them in the sense of like using their products on a day-to-day basis. And so I'm not saying that that's an okay reason to get caught up and be undiversified, but I think that that could explain how people got so caught off guard over the last week, because when something like that happens, it's just it's so easy to just be like yeah, like I'm just I'm just gonna own the largest companies in the world and I use their products every day, so why wouldn't I? Like?
Speaker 1:this is obvious, and everyone who doesn't do this is stupid yeah, I think it makes it easier for them to understand like, oh, apple's, apple's doing. Well, I have an iphone, like I know apple, you see their commercials all the time.
Speaker 3:Netflix.
Speaker 1:Today's amazon prime day exactly yeah like it makes it easier to understand and sometimes just investing and finance in general is like very foreign to a lot of people and it's just like if you were to say small caps are doing well. It's like what's a small?
Speaker 4:cap and then it's.
Speaker 1:Oh, let me name some small cap companies and they're like I've never heard of these before.
Speaker 2:I don't understand it, I don't get it, it's foreign to me and I think that if you remove the last five to 10 year period from the historical data and look back, it would have been to your detriment to only pick large cap US stocks your detriment to only pick large cap US stocks, like all these other areas, I think, have enough historical data to back them up to say, hey, yeah, even though you don't understand these as much as you might, us large cap stocks, you should probably still allocate to them in some capacity if you want to be diversified and you don't want to have to guess when the tide is turning in the market, you know, from large cap to small cap or towards international or value stocks.
Speaker 1:Yeah, yeah. And I think the performance too, like it's all relative. It's not to say that over that period of time that these, uh, anything other than U S large cap stocks haven't been making money. You know, like they, they have been performing solidly, not just just, not not as as well as the us large cap. So it's not like you're out there getting pummeled in some of these other areas. Like you're, you're still making money. If you have money in the over the long term. It's just a trade-off of. You know, if you're owning portions of all of these different asset classes and different types of investments, you're not feeling 100% of the US large cap exposure and performance.
Speaker 2:I'm sure we said and I said no more quotes, but there's enough quotes. During that last episode you were referencing before, tim, I'm sure that we made reference to the idea of diversification, meaning always having to say you're sorry.
Speaker 4:Yes.
Speaker 2:I mean, you're always, by definition. If you're diversified, you're always going to have something that is lagging in the portfolio and something that is leading, and that's part of it and that can work in your favor over the long haul if you can stay disciplined and stick with the strategy, rebalance back into the areas that are lagging and take some profits from the ones that are leading over time. That's what it's all about, but nobody said it was going to be easy.
Speaker 1:Simple. Sometimes. It can be simple, but not easy. We say that a lot too.
Speaker 3:Yep, it's also hard to do when it's time to do it.
Speaker 1:That's the other part of Behaviorally it feels the opposite of what your gut wants you to do or what feels good.
Speaker 3:I think there's also a lot of misunderstanding when we talk about small caps in the sense that there are small caps in general and then there's small cap growth, small cap value. There is the Russell 2000. There is the S&P small cap index 2000, there is the S&P small cap index. These are. You know, when ETFs were initially created they were based off an index. So it was a race to create indexes because then we could build an ETF off of it. But there's pretty large difference between something like the S&P small cap index and the Russell 2000. Do we want to talk about that?
Speaker 2:Yeah, I mean I just think in general, like you can get different flavors of small cap exposure, and having them at all in your portfolio is a decision that I think is beneficial. But then, beyond that, and probably the part that most people are relying on us to research for them is like, if you want to own small caps, how do you do it? And, to your point, these different indexes can get you different flavors of small cap exposure and that's going to impact your performance over the long haul. So I mean, that's that's something that we've spent time in the weeds thinking through for people and you know we have our reasons for how we get that exposure in the portfolios.
Speaker 1:But yeah, so I think that you know good discussion on small caps. They've been in the headlines recently for good performance, but overall, just another beneficial discussion about diversification. It's a good place to wrap up. That was episode 482 of the Malooly Asset Management Podcast. Thanks for listening. We'll see you on the next episode.
Speaker 4:Tom Malooly is an investment advisor representative with Malooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Malooly Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Malooly Asset Management may maintain positions and securities discussed in this podcast.