There has been a lot of discussion about the recent outperformance of the Russell 2000 Index , the small-cap benchmark, to the broader market Let’s take a look back at what the Russell 2000 has actually done and what specific areas of the index to look for opportunities. The outperformance of the iShares Russell 2000 ETF (IWM) to the Invesco Nasdaq-100 and the SPDR S & P 500 (SPY) began in the first week of July (highlighted below). Non-farm payrolls for June were released on July 5 and showed significant revisions in the prior May readings on the headline and private payrolls figures along with an unemployment rate that was slightly above expectations. Then on July 11, things really got started as June CPI came in below expectations and the outlook for the first Fed rate cut became significantly more likely. Lower rates are viewed to be most beneficial to domestic companies who access funding not in the corporate bond markets, but directly from banks that set borrowing costs based on prevailing interest rates. Another look at the same chart of the SPY, QQQ, and IWM with the percent change set to July 5, we see IWM outpacing the SPY and QQQ by a considerable margin (+3.87% vs -1.41% and -8.20%) My approach to investing for my clients at Inside Edge Capital is that the averages are for well…the average investor. I think we can do better. Let’s drill down into the sectors that makeup the Russell 2000 to see who’s leading and lagging since that July 5th turning point. Real Estate, financials, utilities, and health care led the charge in that order. Now, I’ve written about this before on CNBC PRO back in March of this year and expressed caution because 43% of the Russell 2000 companies showed negative trailing 12-month earnings. Yes, lower borrowing costs are going to help small cap companies, but this is just the first cut (hopefully of several) and costs are still considerably higher than they were pre-pandemic. Let’s find out who is actually profitable and could maintain the rally after the initial shine of a fresh rate cut wears off. Where to look in small caps A big component of the Russell 2000 based on market capitalization representation is health care at 18.7%. Yet as you’ll see in the chart below health care is by far the worst performer in terms of trailing 12-month earnings, -$2.094 collectively for the sector. Compare that to financials market cap that is equally sized in the Russell 2000 at 18.0%, yet the financials have made $2.33 collectively in trailing 12-month EPS. That’s what we’re looking for. Check out two names in capital markets I have my eye on: Piper Sandler (PIPR) and Hamilton Lane (HLNE) . I don’t own them but am looking to add. I currently own Jefferies (JEF) and Ares Management (ARES) in our portfolios. Also interesting is that utilities are 19.29% of the total EPS made for the Russell 2000, yet they represent just 2.6% of the total market capitalization. Should the Fed strike a dovish tone after the first rate cut I will be shopping for quality names. One last group that I find interesting is consumer discretionary that has made pretty impressive gains in recent weeks within the S & P 500. Consumer discretionary represents 15.95% of the trailing 12-month earnings in the Russell 2000, is 10% of the total market cap, yet has only advanced 1.64% since that key July 5 turning point. I don’t usually like to play the ‘catch up’ trade, but there could be some opportunities there. -Todd Gordon, Founder of Inside Edge Capital, LLC DISCLOSURES: (Gordon owns JEF, ARES, personally and in his wealth management company Inside Edge Capital. Charts shown are MotiveWave and Excel.) All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
