Can the Russell 2000 keep up the pace? A Look At Earnings, PE

Citi Research analysts Scott Chronert and Louis L Odette provide their take on how small and mid caps are likely to fare in the dying months of 2013 in their study “Small/Mid Cap Topics – Trick or Treat?” of October 28.

Can the Russell 2000 keep up the pace?

Arguments for a likely strong finish are supported (1) by the historical tendency that a strong show during the first ten months is usually repeated during November/December, and (2) a seasonal bias in favor of positive momentum as we head into the year-end.

These ideas are tempered by the observations that trailing PEs are already at high levels, while EPS growth projections are trending lower, per the charts here:

1-rut-drags Mid caps

However, through the looking glass of technicals, Citi points out that there is the possibility of a 3-5% pullback given the currently benign volatility, and which could change given historical tendencies. High RSI readings for the Russell 2000 (INDEXRUSSELL:RUT) also call for caution.

Hunting for more clues

A scan for more clues across 5-year historical data on the performance of November/December versus the preceding 10 months yielded no discernible patterns.

Citi suggest that investors might rotate out of the top performing stocks and into the laggards with a view to (1) take some profits off the table, and (2) take advantage of the better operating leverage offered by these stocks in the context of better economic prospects.

Investors’ reactions to changes in EPS

An indication as to which sectors could be in demand by the year-end is gleaned by comparing, sectorally, changes in Q4 EPS growth projections with the returns obtained across those sectors, in the table below:

2-eps-growth mid caps

Citi analysts find that investors bought sectors such as Materials, Energy and Retailing regardless of negative EPS growth changes. The reasons could include expectations for outperformance in 2014, a reversal in growth estimates or macro viewpoints.

Specific stocks

Citi analysts note that stocks such as Sunedison Inc (NYSE:SUNE), Advanced Energy Industries, Inc. (NASDAQ:AEIS) and TreeHouse Foods Inc. NYSE:THS) have done well because investors appreciated positive sales and earnings revisions.

About the Author

Saul Griffith
Saul Griffith is an investor in stocks, commodities and forex, writing under a pen name. Saul has top accounting qualifications and extensive experience in industry and the financial markets. He also has an abiding interest in breaking news that could be a harbinger of new trends and give insight into an instrument’s potential for providing value, growth or yield.