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Can the US small cap bull market continue?

By: Tom Goodwin, senior research director

The third quarter of 2017 saw the US economy exceed its forecast GDP growth of 2.5% with a gain of 3.0% despite a particularly dramatic hurricane season. As unemployment and inflation remained on the low side, the Fed maintained its federal funds rate target at 1.0%-1.25%, indicating its confidence in the US economy. With this as a backdrop, US equities continued to move upward – especially small caps. As periods of sustained growth continue, market participants are beginning to question how much longer until this bull market dies. Here, I will look at some of the current data points and see how they compare to historical averages.

In the 12-month period ending September 30, 2017, the small cap Russell 2000® Index has a 20.7% return. Since the last major market correction in February of 2016, the Russell 2000 Index has a 60.1% return. How out of the ordinary is this performance? We’ll use valuation ratios, the current length and performance of the small cap bull market, and expected volatility to see if we are indeed outside the norm for small cap bull markets.

First, we can take a look at the historical averages for the Price-to-Book (P/B) ratio. The chart below contains monthly observations going back to 1986. The three parallel lines indicate the historical mean and +/- one standard deviation from that mean. We can see that the current P/B is within the band at 2.42—above the historical average of 2.07, and apparently heading outside of the band, but still far below the peaks of over 3 that occurred during the dot-com boom of the 1990s.

Secondly, we can look at the Price-Earnings ratio, excluding negative earnings to limit outliers (“P/E x Neg”). However, because historical earnings can often be distorted by inflation we must correct for this. To create a series that can be compared like-for-like over time I inverted the P/E x Neg ratio to earnings yield (E/P x Neg) and then subtracted one-year CPI inflation from that to create a real earnings yield series. The chart shows that current real earnings yield is below the historical mean, but well within the historical one-standard-deviation band.

Another way to look at the current bull market is by length and performance. In a previous post I documented that small cap bull markets have lasted a median of 698 trading days and have had a median total index return of 106.8%.[1] The current bull market began on February 11, 2016 and it has been 446 trading days with a total return of 57.6% as of November 15, 2017. So compared to history, neither valuation ratios nor the duration of the bull market seem to be at extremes.

Finally, expected volatility is another indicator that is wise to watch. A high expected volatility would be a possible signal of turbulence to come. The chart below shows the volatility implied by the traded options on the Russell 2000, the Cboe Russell 2000 Volatility Index (RVX). Options are forward looking and so the RVX represents volatility expected by the market. We can see that the RVX is currently at a historically low level.

Of course, past performance is no guarantee of future results. In particular, none of these statistics take into account external events that might impact the market. For example, at the moment the outcome of a major tax bill winding through Congress is unclear and that could have a profound market impact. Only time will tell if the current small cap bull market will fit within a typical historical pattern.

For more detail on this topic please request the FTSE Russell Q3 Small Cap Perspectives or view the following webinar.




[1] T. Goodwin, “Where are we in the small cap cycle?”,


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