YouTube's algorithms know me extremely well. Frighteningly so.
Lately, I have been getting bombarded with Robert Plant clips, including his appearance on "Pop Quiz," a 1980s BBC celebrity quiz program that I was unaware of and that is just striking in its genius. So, OK, Google, I like Led Zeppelin. The connection with stocks is in the opening track from Led Zeppelin II, adjusted by me to reflect the performance of small-caps lately: Whole Lotta Oof. Yes, "oof" is a common refrain among small stock investors as rising interest rates crush smaller stocks.
Why does that happen? The pat answer, and one I have read 1,000 times in the past three weeks, is that higher-growth stocks, which tend to be tech-y in nature, are more sensitive to changes in interest rates. The finance nerd term for this phenomenon is duration. Nasdaq stocks have higher duration than, say, Deere (DE) . We know how many tractors Deere can make, but nobody knows when Elon's much-hyped fleet of robotaxis will appear. That's a quick primer on duration. If it's less likely to occur or will only occur in the distant future; consequently, you need to discount it, and using a higher discount rate produces a lower present value.
However, that academic argument really sounds like Charlie Brown's adults when you actually own the stocks. Wah-wwaaah-wuh-awwah-wah. Yes, it is just noise. When will this stop?
A look at the Russell 2000 shows this market downdraft could last a very long time. Why? Because in our computer-addled world of equities, stocks that are down are considered less attractive than ones that have risen. Screw Benjamin Graham, I want to invest in robotaxis!
Here on Jan. 20, year-to-date performance is somewhat irrelevant, but trailing one-year performance is paramount to the algos, at least the ones that I know. As of this writing, the Russell is down 4.11% year over year, and that's where the pain starts.
As of Dec. 31, 2021, the Russell's largest members, with their FTSE Russell industry groups, were:
AMC Entertainment (AMC) -- Consumer Discretionary
Synaptics Inc. (SYNA) -- Technology
Lattice Semiconductor (LSCC) -- Technology
Eastgroup Properties Inc (EGP) -- Real Estate
BJ's Wholesale Club Holdings (BJ) -- Consumer Discretionary
Tetra Tech Inc. (TTEK) -- Industrials
Saia Inc. (SAIA) -- Industrials
Ovintiv Inc. (OVV) -- Energy
Tenet Healthcare Corp. (THC) -- Health Care
Willscot Mobile Mini Holdings (WSC) -- Industrials
AMC is No. 1; a meme stock is your largest constituent? That's the potential for a Whole Lotta Oof. AMC is down 57.5% in the past six months, but up 517% in the past year. As you can see, base effect is important, and the Russell is showing a year-on-year decline even with that meme-inspired jump in its post-rebalancing largest constituent.
There is weakness elsewhere, and in this market for the past six months there has been weakness everywhere except for a few Nasdaq megacaps. The Russell 2000 has declined by 6% in the trailing six-month period, and that must have the algos worried. I know enough of them to confirm that.
What's next for small stocks? I can see two scenarios. If interest rates continue to rise/bond prices continue to fall and the 10-year U.S. Treasury yield rises through 2%, it will be Katie bar the door. Fund managers are going to dump these little guys.
If bond prices recover and yields fall -- I can't think of any valid reason why this to occur given the generational inflation wave the world is facing -- the Russell 2000 Index, RUT, will be fine.
To own small stocks now, you are really betting on the bond market. It is demonstrable that Fed Chairman Jerome Powell and Treasury Secretary Janet Yellen don't care about inflation, but even they are beginning to pretend to care. The Fed's pullback on quantitative easing could just as easily be viewed as quantitative tightening. That just doesn't feel good to managements of smaller, and often more leveraged, companies, and that's where the Russell lives.
Be careful here. No one wants a Whola Lotta Oof in their portfolio. Watch the bond market. The piper is calling, Don't ignore him.
