Small caps lead broad market rally in 2003

Sunday 11th January 2004

According to indexes produced by Russell Investment Group, small cap stocks surged in 2003, leading a rebounding US equity market and outperforming their large cap counterparts by more than 17 percentage points.

Russell indexes serve as performance standards against which money managers and mutual funds can be evaluated. More than US$182 billion is invested in index funds that use the Russell indexes as their model.

The small cap Russell 2000 Index gained a record 47.3% for the year, while the large cap Russell 1000 Index increased 29.9%.

In Australia, a similar trend was clearly evident over 2003, with small caps (small ordinaries) recording a 32.3% gain, more than doubling the performance of large cap stocks (S&P/ASX 100) which recorded a solid gain of 13.8%.

"2003 finally gave investors plenty to celebrate, particularly those who invested in small cap stocks," said Dennis Jensen, senior research analyst for Russell in the United States. "Not since 1979 have we seen such a wide performance gap in favour of small caps relative to large caps in the United States."

This year's 17.4% gap in favour of small caps falls just short of the record 20.8% gap in 1979, but small caps now have outperformed large caps for five consecutive years, including each of the final three quarters of 2003.

Overall, Russell's family of 21 indexes reflected a banner year for investors, with gains ranging from 26.6% for the Russell Top 200 Growth Index to 48.5% for the Russell 2000 Growth Index.

"Market exposure in 2003 was beneficial regardless of style or sector," said Jensen. "But those who took a chance with smaller, economically-sensitive stocks generally fared much better."

The technology sector in the broad-market Russell 3000 Index led all others in 2003 with a 50% gain. By contrast, sectors generally categorised as defensive lagged: utilities (17.3%), consumer staples (18.3%), and health care (19.9%).

"Those stocks that suffered the most during the bear market did quite well in 2003," said Jensen. "They were pounded when times were tough but gained a lot of leverage as the economy grew this year."

However, Jensen added that many of this year's high flyers still haven't recouped from their losses suffered when the late 1990s technology bubble burst.

"Even if a stock doubled this year, it may not have made up for a previous 90% loss," said Jensen.

In the fourth quarter, small caps continued to outperform, though value stocks pulled even with their growth counterparts. The Russell 3000 Growth Index (31%) and the Russell 3000 Value Index (31.1%), for example, were nearly equal in performance for the year, but the value index (14.4%) outperformed the growth index (10.6%) in the fourth quarter.

In addition, economically sensitive sectors in the Russell 3000 that were considered 'old economy' sectors during the technology bubble, such as producer durables (21.4%) and materials & processing (22%), continued their strong run in the fourth quarter.

By contrast, the technology sector (13.2%) took a breather.

"Valuation mattered in the fourth quarter, but for the year, investments in high beta, cyclical stocks, regardless of style, dominated the market, particularly among the smaller stocks," said Jensen.

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