Photographer: Michael Nagle/Bloomberg

Hedge Funds Are in Love With Small-Caps Again

Updated on
  • They’re long Russell 2000 futures for 1st time in four months
  • A reversal from May, when bearishness hit highest since 2014

The violent rotation gripping U.S. equities has chased professional investors back into small-cap stocks.

In just two weeks, hedge fund positioning in Russell 2000 Index mini futures went from the most bearish in six years to the most bullish in four months. It’s the biggest about-face on record, according to Commodity Futures Trading Commission data compiled by Bloomberg that goes back to 1994.

While the reason for the flip-flop is hard to pinpoint, it’s mirroring a larger reallocation across U.S. stocks that has sent bank shares up in seven of the last nine days and lifted other sectors that rose in the aftermath of President Donald Trump’s election. Financial firms dominate the small-cap universe, making up almost a third of the Russell 2000 Index, almost twice the share as in the S&P 500.

Another driver is the narrowing of credit spreads, an indication of financial magnanimity that bodes well for smaller companies whose leverage is near all-time highs, according to Bank of America Corp.

Bulls hold sway over small-cap futures for the first time since February, with large speculators net long 7,500 contracts in Russell 2000 minis on June 13, according to data released Friday. The bullish stance contrasts with two weeks earlier, when they were net short by 73,000 contracts.

Optimism is rising as the Russell 2000 is up 2.9 percent this month, poised to beat the S&P 500 Index by the most since Trump won the election in November.

But betting the outperformance will last may be a mistake as earnings growth is poised to lag behind the market for a fifth straight year, BofA strategists led by Dan Suzuki wrote in a note last week. Small-cap companies will boost profit by 5.7 percent this year, about half the pace analyst forecast for the S&P 500.

That’s not good news for a group whose shares have been on a roller coaster since the election. The Russell 2000 led the market’s rally in the first month following the November vote amid speculation Trump’s growth agenda would benefit domestic-oriented companies. As optimism over tax cuts and easier regulations started fading, small caps lost some of their luster. From January to May, they trailed the S&P 500 by almost 7 percentage points, the worst performance to start a year since 1998.

    Before it's here, it's on the Bloomberg Terminal.