Health Care, Materials Lead The Way In Small And Midcaps Rally

Last week, small and Midcaps stocks compensated for losses in the previous week, with the Russell 2000 (INDEXRUSSELL:RUT) index surging +4.0%, the Russell Midcap (INDEXRUSSELL:RMCC) up 3.4% and the Russell 2500 (INDEXRUSSELL:R25I) gaining +3.8%. Comparatively, the SPX rose 3.2%.

The star sector performers were Health Care and Materials, while Consumer Staples, Consumer Discretionary and Energy were the laggards, according to the weekly SMID Cap “Rap” research note from Citi analysts Scott T Chronert and Louis L Odette.

Small and Midcaps year-to-date performance by sector and style

This is shown in the table below. Positive performance can be observed YTD in Real Estate, Health Care, Telecom and Utilities.

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Key factors impacting small and midcaps

  • As already seen from the above table, consumer sectors have been a drag on small and midcap stocks’ performance, while Health Care has led from the front. However, on a month-to-date basis Consumer seems to be making amends.
  • Q4 and Q1 weather conditions could lead managements to adjust 2014 full year guidance, though Q4 earnings continue to tend towards positive surprises. Of concern is Citi’s projection of only +1% GDP growth in Q1 due to the aforesaid weather factors. “We suspect that Q4 and early Q1 weather issues may be providing many managements with cover to walk down full year expectations. The sooner 2014 index level earnings can get worked lower, the better, as we believe that will set SMID up to benefit from improving economic conditions later in the spring,” say the analysts.
  • Though small cap value funds are outperforming growth funds, the percentage of small cap funds that are outperforming their indices YTD has turned lower compared to what was observed towards the close of 2013, hinting at a loss of upside momentum.

Chart of the week

The chart of the week below explores the relationship between weather (as measured by the National Average Precipitation Moving Average) and growth in industrial production. The analysis is relevant in the context of country-wide inclement weather and the release of below-expectation economic data.

2-chart-of-the-week MidCap

Citi comments that industrial production adjusts to precipitation with a lag of a year and that a correlation of 0.42 exists between the two data series.

More importantly, it seems that though demand could be impacted adversely in the short term due to bad weather, thereby depressing production, the “pent-up” demand later triggers a compensatory increase in production.