Mark Barnes, PhD,
Indhu Raghavan, CFA,
- In July, the Russell 2000 small-cap index outpaced Russell 1000 in a shift from their relative performance during the first half of 2024. This shift seems to be related to changes in the US monetary policy outlook.
- From July 2023 to April 2024, as the 10-year US Treasury yield rose, Russell 1000 outperformed Russell 2000, and vice versa. However, in May and June 2024 this pattern reversed. AI optimism and the focus on mega-cap tech earnings and prospects may have contributed to the tech heavy Russell 1000’s continued outperformance even as the long-term yield fell.
- In July, the small-cap index closed much of the relative underperformance from May and June and there was a general broadening of the equity rally.
- Whether the shift in Russell 2000’s relative performance will be sustained depends on the many drivers of returns and the continuation of the benign macro backdrop that has supported the US equity rally this year.
On July 11 and 16, the Russell 2000 small-cap index lurched 3.6% and 3.5%, respectively, its two largest single day moves of the year as of the time of writing (23 July 2024). It helped Russell 2000 outpace the Russell 1000 index thus far in July in a shift from their relative performance during the first half of 2024 as shown in Exhibit 1.
Exhibit 1: Russell 1000 and Russell 2000 total return (%)
Source: FTSE Russell and LSEG. Data as of 23 July 2024. Please see the end for important legal disclosures.
Exhibit 2 illustrates the dramatic nature of the July moves in the Russell large-cap and small-cap indices and their style cohorts. Month-to-date, leadership has shifted from large-caps to small-caps and from Growth to Value in both size segments.
Exhibit 2: Russell indices cumulative return, July 1-23, 2024 (rebased 30 June 2024, USD)
Source: FTSE Russell and LSEG. Data as of 23 July 2024. Please see the end for important legal disclosures.
These moves seem to be related to changes in expected US monetary policy.
On July 11, the June consumer price inflation (CPI) for the US was released and was lower than the May CPI. Coming on the back of two successive months of disinflation, it provided markets greater confidence in the Fed’s expected monetary easing trajectory.
On July 16, the June retail sales numbers were released, which were unchanged from May when expectations were for it to decline. As an indicator of the aggregate health of the US consumer, it provided markets one data point for expecting the benign growth picture to be sustained.
Over the last year, the Russell 2000 index has had two other similarly large daily moves as in July (Exhibit 3) that happened close to the release of lower CPI data. In each instance, the 10-year US Treasury yield declined on expectations of an end to the rate hiking cycle and prospects for monetary easing. Further, the associated move in Russell 2000 was larger than the move in Russell 1000. indicated on the chart.
Exhibit 3: The Russell 2000 index’s four largest daily total returns, July 2023 – July 2024
Date |
Russell 1000 (%) |
Russell 2000 (%) |
10-year yield change (bps) |
|---|---|---|---|
16-Jul-24 |
0.8% |
3.5% |
-6.20 |
11-Jul-24 |
-0.7% |
3.6% |
-8.70 |
13-Dec-23 |
1.5% |
3.5% |
-17.30 |
14-Nov-23 |
2.1% |
5.5% |
-19.10 |
Source: FTSE Russell and LSEG. Data as of 23 July 2024. Please see the end for important legal disclosures.
Exhibit 4 illustrates the relationship between long-term interest rates, that have been top of mind for investors since the Fed began tightening policy rates, and the relative performance of Russell large-cap and small-cap indices over the last year. The table beneath the chart delineates this timeframe into five periods based (approximately) on the shifts in the trajectory of long-term interest rates. It shows the total returns and relative return for these indices along with the change in the 10-year US Treasury yield for each period that is also indicated on the chart.
Exhibit 4: Russell 1000 and Russell 2000 relative return (USD, LHS), 10-year US Treasury yield (%, RHS), July 2023 – July 2024.
Source: FTSE Russell and LSEG. Data as of 23 July 2024. Please see the end for important legal disclosures.
| Period | Start | End | Russell 1000 (%) | Russell 2000 (%) | Russell 1000 - Russell 2000 (%) | 10-year yield change (bps) |
|---|---|---|---|---|---|---|
| 1 | 30-Jun-23 | 31-Oct-23 | -5.50% | -11.60% | 6.10% | 105.6 |
| 2 | 31-Oct-23 | 29-Dec-23 | 14.70% | 22.40% | -7.60% | -101.5 |
| 3 | 29-Dec-23 | 30-Apr-24 | 5.60% | -2.20% | 7.80% | 82.4 |
| 4 | 30-Apr-24 | 28-Jun-24 | 8.20% | 4.00% | 4.10% | -34.1 |
| 5 | 28-Jun-24 | 23-Jul-24 | 2.00% | 9.60% | -7.60% | -10.4 |
Source: FTSE Russell and LSEG. Data as of 23 July 2024. Please see the end for important legal disclosures.
From the end of June 2023 to the end of April 2024, covering the first three periods, as the 10-year Treasury yield rose, Russell 1000 outperformed Russell 2000, and as the long-term yield fell, the large-cap index underperformed the small-cap index. However, in May and June of this year (during the fourth period) we saw this pattern reverse. As long yields declined once again after the April market pullback, Russell 1000 continued to outperform Russell 2000 fueled by AI tailwinds and healthy earnings among mega-caps and tech companies in a much narrower equity rally than the one we saw earlier in the year, as we discussed in our quarterly Russell US Indexes Spotlight. In fact, a handful of Russell 1000 sectors such as tech hardware and software and electricity (in the Utilities industry) contributed the bulk of the large-cap index’s returns.
Further, at the end of June, the Russell 1000 index traded at historically high forward valuations. By contrast, despite the market beginning to price in lower rates, the Russell 2000 stayed downbeat in Q2. At the end of June, the small cap to large cap valuation premium was among the lowest 5% of observations over the last 20 years.
The other point to note about the July 2024 moves is that they did not just represent moves into the Russell 2000 at the expense of the Russell 1000. We compared the daily moves in the market-cap weighted Russell indices with the moves in their equal-weighted counterparts (Exhibit 5). Although Russell 1000 lost -0.7% on July 11 and gained only +0.8% on July 16, the equal-weighted Russell 1000 index rose by +1.7% and +1.8%, respectively, on those days. This suggests that there was a broadening of the rally even within the large cap Russell 1000 index.
Exhibit 5: Russell 1000 and Russell 2000, market-cap weighted and equal-weighted indices’ total return (%)
| Date | Russell 1000 (%) | Russell 1000 equal-weighted (%) | Russell 2000 (%) | Russell 2000 equal-weighted (%) |
|---|---|---|---|---|
| 16-Jul-24 | 0.80% | 1.80% | 3.50% | 3.70% |
| 11-Jul-24 | -0.70% | 1.70% | 3.60% | 4.30% |
| July 1-23 | 2.00% | 3.30% | 9.60% | 10.30% |
Source: FTSE Russell and LSEG. Data as of 23 July 2024. Please see the end for important legal disclosures.
Conclusion
The drivers of returns, such as interest rate expectations and AI tailwinds, that the market chooses to prioritize at any given point matter. AI optimism and the focus on mega-cap tech earnings and prospects may have contributed to the tech heavy Russell 1000’s continued outperformance of Russell 2000 during May and June when long interest rates fell, leading to a divergence in the relationship observed previously. In July, the small-cap index closed much of that relative underperformance. In addition, the stretched valuations among large-caps collectively may help to partly explain why when the market priced in another bout of good news on interest rates on July 11, the Russell 2000 index rallied more than its large-cap counterpart. In other words, the starting point for valuations matter.
Further, there was a broadening of the rally even within the Russell 1000 index, suggesting that the contrast in performance in July from earlier may not be strictly between large-caps and small-caps, but between the leaders of the US equity rally YTD and the rest.
The shift in relative performance in July between Russell 1000 and Russell 2000 was dramatic. Whether it will be sustained depends on the many drivers of returns and the continuation of the benign macro backdrop that has supported the US equity rally since the end of last year.
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