Small-cap stocks are wobbling, and that could mean trouble ahead for the broader market. The Russell 2000 is barely above the flatline for 2023, gaining just 1.4% in that time. The small-cap index is also down more than 10% from a 52-week high. That decline put the benchmark near its 200-day moving average, indicating “very weak” overall and a potentially downside break, BTIG said in a note. By comparison, the large-cap S & P 500 and Nasdaq Composite are up 12.7% and 26%, respectively. The weakness in small cap names has made Wolfe Research analyst Rob Ginsberg cautious again on the market after turning positive at the start of 2023. He noted that, relative to the broad market index and the tech-heavy Nasdaq, the Russell 2000 is now trading at the lowest levels back to the period between 2000 and 2003. “Good, healthy bull markets are led by a lot of participants, and the inability of small caps to kind of participate has definitely been a concern now,” Ginsberg said. “We’re probably within two or three months, in my opinion, [of] a pretty meaningful low in small caps relative to the rest of the market.” .RUT .SPX YTD mountain Russell 2000 lagging Although Ginsberg is looking to buy the dip in small caps, he thinks the market can still go lower. “We’re getting close. And so I think we might have 5% to 10% to go before that oversold condition develops,” Ginsberg said. Attractive valuation not enough? There’s another source of concern regarding small caps. Jefferies’ small- and mid-cap strategist Steven DeSanctis noted that the group hasn’t been able to recover despite its attractive valuation. “When I look at valuations, we’re back to levels that we haven’t seen since February of 2002. Whether that’s just simply relative PE or our more complicated relative valuation model,” DeSanctis said. Still, he added that small caps have struggled to escape the headwinds from the regional banking crisis earlier in the year. How to play small caps There’s one sector both Wolfe’s Ginsberg and DeSanctis like when it comes to small caps: energy. “Energy has been my favorite sector for months now. That’s what I think continues to work,” said Ginsberg. DeSanctis also favors energy and highlighted cyclical names. He added that small caps in the cyclicals market have traded under 13 times earnings — and better than secular growth names. “I think a lot of stuff has already been priced into small cap stocks,” said DeSanctis. “Small cap is cheaper than large cap, but you need the earnings growth to turn, [or] at least to be more comparable between the two size segments, which might be something that we’re going to see in 2024.” — CNBC’s Michael Bloom contributed to this report.
