Small-cap stocks surge as broader U.S. market stalls. Here’s why.

The small-cap gauge has been left behind in 2023, gaining around just 5.4% so far in 2023 versus an 11.6% rise for the large-cap benchmark S&P 500
SPX,
+0.24%
and a 26.9% jump for the tech-heavy Nasdaq Composite
COMP,
+0.36%.
Both large-cap indexes have seen gains driven by highflying, megacap tech stocks in 2023.

Read: These stocks can play catch-up with megacap tech, lifting the S&P 500: Stifel’s Bannister

Those gains mean the eight biggest megacap tech stocks accounted for nearly 28% of the market-cap-weighted S&P 500 and nearly 55% of the tech-concentrated Nasdaq-100
NDX,
+0.01%,
noted Louis Navellier, founder of Navellier & Associates.

See: Big Tech’s added bulk in S&P 500 in 2023 outweighs index’s energy sector, DataTrek says

Small-caps are flipping the script as June gets under way, with the Russell 2000 gapping higher Friday after a much stronger than expected May nonfarm payrolls rise.

Tuesday’s small-cap rally looked like “a continuation of the market reaction we saw from last Friday on the heels of another very strong jobs report which to many put the prospects of a ‘soft landing’ back on the table,” Greg Czarnecki, portfolio specialist for William Blair’s small- to midcap value equity strategies, told MarketWatch.

“Small-caps, and small-cap value in particular, is the most economically sensitive sector of the domestic equity market. We’ve seen this sector rally hard, particularly the cyclicals and industrials, over the past few sessions as recession fears have seemingly faded,” he said.

It’s too early to tell if small-caps are out of the woods. But valuations for the segment were already steeply discounted compared with long-term averages and relative to large-caps, he noted, with small-caps having priced in a severe slowdown.

The Russell 2000 outperformed the S&P 500 by around 2.5 percentage points, its biggest such gap since Nov. 1, 2021.

Navellier, in emailed comments, said the expectation “is that either the small-cap stocks in the Russell 2000 and microcap indices will ‘catch up’ or the eight big megacap technology stocks will ‘crash and burn,’” Navellier said, in emailed comments.

“Since the ChatGPT and AI craze is boosting Microsoft
MSFT,
-0.67%
and Nvidia
NVDA,
-1.32%,
plus making Google
GOOG,
+1.01%

GOOGL,
+1.03%
very nervous as alternative search engines materialize, I think the rest of the stock market is expected to ‘catch up’ as the breadth and power of the overall stock market improves in the upcoming months,” he wrote.

In One Chart: Small-cap stocks lag in 2023, but here’s where they’re ‘finally’ starting to see positive earnings revisions