Long Term Perspective

The Russell 2000 jumped 17.0 percent in 2006, following a mere 3.3 percent rise the prior year. For the latest year, the Russell 2000 outpaced most major indexes with the DJIA coming in at 16.3 percent and the S&P500 at 13.6 percent. As in 2005, most market analysts were surprised at the strength of the small cap sector last year, expecting that the large cap sector would perform better. But again they were wrong. Its 10-year average return firmed to 9.5 percent in 2006 from 9.2 percent the previous year. The Russell 2000 is a benchmark index for the small capitalization sector. It has a longer history than the S&P Small Cap Index and also has a wider base (2000 stocks vs. 600 for the S&P).

Short Term Perspective

Small cap stocks seem to get hit more dramatically than large cap stocks in times of uncertainty but they also tend to rebound more sharply in economic recovery. This index gets revised each year in July when stocks no longer fitting the “small-cap” criterion are removed from the index. Fast growing high tech companies fit this description in the late 1990s – although many former high flyers were removed from the index in 2001, 2002 and 2003. Growth in 2004 was exceptional relative to the large cap market.

This index showed solid gains on a year-over-year basis early in 2006 and again late in 2006. This pattern reflects the Fed tightening weakening the index heading into mid-year of 2006. The Small Caps in mid and late 2007 was hit hard by subprime losses, the liquidity crunch, and fears of recession – even though the Fed rate cuts in September and October did provide some support. In 2007, the Russell 2000 in November was down 2.3 percent on a year-on-year basis, compared to up 8.0 percent in October. At the end of November, the Russell 2000 was a laggard to other indexes with a 2.5 percent decline since year-end 2006.

This index was hit hard in November by fears of recession and worries that the Fed would not cut interest rates aggressively.  The Russell 2000 index dropped 7.3 percent in November, following a 2.8 percent gain in October.