The Bottom Line
- February’s volatility spike was felt in most markets, some more than others. The differences in volatility between large-caps and small-caps are instructive, telling a tale of mean reversion.
- Small-cap stocks as a group have shown more volatility than large-caps over time – for reasons that aren’t necessarily based on fundamentals. For active, fundamentals-driven investors, that small-cap volatility can represent a valuable opportunity to buy good companies at attractive prices.
- But large-caps have recently taken the lead in volatility – thanks to both real and perceived macroeconomic change. Looking at the differential between major volatility indexes for small-caps and large-caps, February turns out to be record-breaking, with relative large-cap volatility jumping to the highest level since these indexes were created.
- That’s larger than during the 2007-8 Global Financial Crisis, the China-related market correction of August 2015 and the January 2016 market slump which was brought to an end by Fed reassurances the following month –three spikes also driven by macro events.
- Perhaps the most revealing characteristic of the February spike is its quick reversal to a level roughly in line with historical levels – suggesting that the market correction may have run its course, at least for now.
- Why might small-caps be less vulnerable? Though it’s clearly true that macro factors affect the long-term prospects of companies of all sizes, the same is likely not true in the very short-term, where valuation can be more of a driver of stock price behavior than long-germ forces.
- Only time will tell if large-caps stay settled down. But in the interim, the relative indifference of small-caps to external factors – at least in the short term – is a feature worthy of consideration for that part of the market.