Night in the RUTs

Christian DeHaemer

Posted March 27, 2024

Night in the RUTs

When I was a young lad in the late 1970s, my older brother had an Aerosmith concert t-shirt back when they still played interesting music. The shirt read “Night in the Ruts” on the front. On the back, the “N” and “R” were crossed out and transposed with a graffiti font, and it read “Right in the Nuts.”

To my adolescent mind, it was the coolest shirt in the known universe.  Once he caught me wearing it at the go-cart track on a Friday night and I had to go home without a shirt.

RUTs Rising

The ticker for the Russell 2000, which is the bottom 2000 stocks of the Russell 3000 index, is RUT, of course. RUT is an index of small- and medium-sized companies with a mean market cap of $900 million.

Traditionally, it performs better than large blue-chip stocks but that hasn’t been the case of late.  Here is the S&P 500 in gold and the Russell 2000 in black.  It’s a five-year chart.

Investors have been chasing the “Magnificent Seven” stocks for the past ten or fifteen years.   These stocks have grown so big that they make up 32% of the weighting of the S&P 500.

Meanwhile, the small-cap stocks as represented by the Russell 2000 make up just 3% of active portfolios.

In investing, the highest returns are always from buying what is out of fashion.  You profit as they return to the mean.  Chasing hot stocks and market darlings ends in tears.

A few months ago the Wall Street Journal did some research going back 50 years and discovered that small-cap stocks do the best when interest rates plateau and start to drop.

From the WSJ:

“When we look at small-caps and growth stocks, we see even better returns during the first half of rate plateaus. For small-caps, the average annualized return is 27.6%, and for growth stocks, it is 26.3%. Those returns cool off in the second half of plateaus for both asset classes—averaging 3.5% and 10.2%, respectively.”

When interest rates drop small caps do better.  This happened in 2004, 2010, and 2020.

There is building evidence that consumers are in trouble and that unemployment will start to rise ensuring multiple rate cuts sooner than the market expects.  It might be a good idea to increase your exposure to small caps.

All the best,

Christian DeHaemer
Pro Trader Today