U.S. small-cap stocks will probably lag the S&P 500 next year, says DataTrek. Here's why.

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By Christine Idzelis

‘Marginal changes in HY spreads move small cap stock prices,’ says DataTrek

U.S. small-cap stocks will probably underperform the S&P 500 index in 2022, according to DataTrek Research.

“Our reasoning is straightforward,” wrote DataTrek co-founder Nicholas Colas in a note Thursday. “This asset class needs the tailwind of lower US corporate high yield spreads over Treasuries to outperform large caps, but spreads are already at/near their historical lows.”

About a third of the Russell 2000 index , a gauge of U.S. small-cap stocks, is unprofitable and “these companies need ready access to cheap capital,” according to Colas. High-yield debt spreads “are a proxy for the availability and cost of that capital,” he said in the note.

   "Put another way, marginal changes in HY spreads move small cap stock prices,"   wrote Colas. 

Read:Easy money in junk debt markets helps borrowers, but are investors risking too much in a reach for yield?

In the U.S. junk-bond market, high-yield spreads were 303 basis points over comparable Treasurys on Dec. 29, according to a chart on the website of the Federal Reserve Bank of St. Louis, which cites Ice Data Indices as its source.

Could high-yield spreads fall to lows seen in 1997 and 2007? wrote Colas. “Maybe, but we don’t think markets will pay much for that move to all time record lows since history so clearly says they are unsustainable.”

“Without the catalyst of lower high yield corporate spreads,” said Colas, “it is hard to like the Russell over the S&P 500.”

The S&P 500 index, which measures the performance of U.S. large-cap stocks, has put up big gains in 2021.

The S&P 500 has soared around 28% this year, trouncing the Russell 2000’s gains of around 15%, according to FactSet data including Thursday afternoon trading. The S&P 500 was trading about 0.1% higher Thursday afternoon, pressing into fresh record territory, while the Russell 2000 was up about 0.9%, the data show, at last check.

The S&P 500 notched its 70th record high Wednesday, scoring an unusually long series of all-time peaks this year. That’s the most since 1995, when the S&P 500 logged 77 record closes, according to Dow Jones Market Data.

Next year probably won’t be bad for the S&P 500, according to the DataTrek note.

“Looking back at annual S&P 500 returns since 1928, we find that really bad years (down more than 10 percent) are rarely preceded by really good years (such as the +28 pct we’ve had in 2021),” Colas wrote. The exceptions were in 1937 and 1973, which saw double-digit percentage drops after really strong S&P 500 gains the year before, the note shows.

“There’s only an 18 percent chance (2 of 11 years) that 2021’s strong return will end in tears in 2022,” said Colas, of the S&P 500.

Read:’Proceed with caution’: here’s what Wall Street analysts see for the U.S. stock market in 2022

-Christine Idzelis

 

(END) Dow Jones Newswires

12-30-21 1421ET

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