In one corner of the U.S. equity market, investor enthusiasm is exceeding the frenzy of the Internet bubble.
Small-cap shares tracked by the Russell 2000 Index have rallied for seven straight quarters, the longest stretch ever, sending valuations 26 percent above levels at the height of the 1990s rally. Gains in stocks from LogMeIn Inc. to Athenahealth Inc. have pushed the gauge up 248 percent since the bull market began five years ago, leaving price-earnings ratios about three times as high as for shares in the Standard & Poor’s 500 Index.
Surging small-caps were cited by Federal Reserve Governor Daniel Tarullo last month as one reason policy makers should ensure they’re not creating systemic risk in financial markets. While the increase in the Russell 2000 reflects speculation America’s economy will expand faster than the rest of the world, investors may be getting ahead of themselves, according to Matthew Peron of Northern Trust Corp. in Chicago.
“Small-caps are all getting painted with the brush of success,” Peron, managing director of global equities at Northern Trust, said on March 19 by phone. His firm oversees about $885 billion. “The story is more nuanced than that.”
U.S. stocks rose last week, with the S&P 500 climbing 1.4 percent and the Russell 2000 adding 1 percent, as better-than- forecast data on jobless claims and manufacturing offset comments by Federal Reserve Chair Janet Yellen that interest rates could rise in the middle of next year. The benchmark gauge for smaller shares has risen 2.6 percent this quarter, compared with a 1 percent gain in the S&P 500.
Small-caps, whose market value averages $1.07 billion, have led the bull market as three rounds of monetary stimulus from the Fed drove investors into riskier assets. The Russell 2000 has returned 30 percent a year since March 2009, compared with a 25 percent increase in the S&P 500. Pier 1 Imports Inc., a Fort Worth, Texas-based furniture store, and Keryx Biopharmaceuticals Inc., a developer of renal-disease treatment in New York, rose the most, each advancing about 13,000 percent during the period.
The outperformance accelerated this year even as earnings growth trailed large-caps. Profits from Russell 2000 companies climbed 6.8 percent in the last quarter, compared with 8.6 percent in the S&P 500. While bigger companies exceeded analysts’ estimates by a combined 4.6 percent, smaller firms missed by 13 percent, data compiled by Bloomberg show.
“The space has undoubtedly been on fire,” Jim Russell, who helps oversee $115 billion as a senior equity strategist for U.S. Bank Wealth Management in Cincinnati, said in a March 19 interview. “Trees don’t grow to the sky and you have to be wary of what you pay for that growth.”