January is starting out where 2020 left off: small-caps are leaving large-caps in the dust. So far, the Russell 2000 Index is outpacing the S&P 500 Index by 5.4%. If the month stopped here, that would be the second-best outperformance for the entire month of January in the past 20 years, and it easily exceeds the average relative return.

Just because a trend starts the year strong doesn’t mean it will carry through. January 2006 was the best relative small-cap performance in the last 20 years. But that price action eroded throughout the year, ending with small-caps only 3% ahead of large-caps. And in two of the three best years for small-cap relative outperformance over the last two decades, it was large-caps that did better in January. As every investment disclosure always points out, past performance is no guarantee of future returns. 

A disciplined, active-management process may be able to successfully navigate a trend like this as we start on the road back to normal life. Horizon Investments has been growing increasingly positive on smaller-cap stocks for months. After this huge run, what are we watching to remain positive? In short, earnings. Small-cap profits need to meaningfully inflect higher in the back half of 2021. The dual shocks, from the trade war in 2019 and the Covid shutdowns in 2020, have had an outsized impact on small-cap earnings. Now that business leaders are getting some clarity around a return to normal, a recovery in earnings will be key to sustaining the narrative of small-over-large for the rest of this year.

Further reading:

Russell 2000 Versus Apple Trend Reversal Has More Room to Run
In Current Markets, Only Two Words Matter: Stimulus Spending
Top 2021 Themes: Horizon Investments’ New Year Special Report
PIIGS Fly and Other Stories of Investors Reaching for Risky Bets
Bond Market Bears Growling as 10-Yr Yield Tops 1%
It’s Getting Harder to Fund Retirement Using Bonds
7.9 Trillion Reasons Not to Fight the Fed, ECB, BOJ or BOE

This commentary is written by Horizon Investments’ asset management team. For additional commentary and media interviews, please reach out to Chief Investment Officer Scott Ladner at 704-919-3602 or sladner@horizoninvestments.com.

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