Russell 2000 Bull Run Led Almost Entirely By Biotech/Pharma

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The Russell 2000 (INDEXRUSSELL:RUT) is up 2.2% last week, beating out the Russell Midcap (INDEXRUSSELL:RMCC) and S&P 500 (INDEXSP:.INX). Consumer discretionary was the best performing sector for the week, but year-to-date gains are heavily concentrated in biotech, and continued follow through from the RUT will require financials and industrials to start pulling their weight in coming months.

Russell 2000 returns are highly concentrated

“To make a point as to concentration of return contributions, the top 41 Russell 2000 (INDEXRUSSELL:RUT) stocks on the list have contributed a return equal to the index return,” writes Citi analyst Scott T. Chronert. “Even more telling, of the top 50 Russell 2000 return contributors, nearly half are Health Care stocks, with Pharma/Biotech dominating.”

The Russell 2000 (INDEXRUSSELL:RUT) health care sector had 16.6% average returns, but even the sector breakdown hides some important details. Health care services and equipment are performing roughly in line with the market so far this year, and the sector growth is being driven by pharma/biotech stocks specifically. RUT pharma/biotech is up 24% for the year and is currently valued at roughly 10x 2014E sales ($168 billion sector valuation v $16.7 in projected sales).

The median return for the Russell 2000 is actually 0%, and it’s just 1.6% for the Russell Midcap (INDEXRUSSELL:RMCC), showing how important stock picking is now for investors interested in small and midcap stocks.

Biotech earnings are being influenced by the relatively high rate of M&A activity that we have seen for the last few months. The different mix of health care companies in the Russell Midcap (INDEXRUSSELL:RMCC) may explain why the sector has made a smaller contribution to RMC gains than the Russell 2000, and growth strategies have outperformed value strategies on the RUT because they tend to be overweight on health care.

Consumer spending rebounding from a weak January

Financials and industrials have underperformed the market so far this year, and considering they make up 40% of the Russell 2000 (INDEXRUSSELL:RUT) and a third of the Russell Midcap (INDEXRUSSELL:RMCC), continued underperformance will be a drag on the overall index if health care momentum starts to slow. Chronert doesn’t try to forecast when this might happen, but he does call the question of how long health care can maintain its momentum “a key discussion point.”

Consumer spending is still behind for the year, but its momentum started to catch up on the Russell 2000 in February and pulling the sector ahead of the market on the Russell Midcap (INDEXRUSSELL:RMCC).  Energy also improved on both indexes after underperforming in January.

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