More Pain Ahead For Small Caps, Credit Suisse Says

As if small-caps needed any more bad news, here comes Credit Suisse predicting more pain ahead.

Reuters

Credit Suisse strategists Lori Calvasina and Sara Mahaffy explain why:

January, we saw two very conflicting signals in our DRIVERs framework – alarmingly expensive valuations that called for a decline in small cap stock prices over the next year, alongside a robust economic forecast that called for mid-teen returns in the R2000. Today, the economic forecast is cloudy, and valuations remain highly problematic, with most major multiples in small cap still up around historical or post TMT bubble highs. The R2000 forward P/E was at 19.6x to start the year, and was sitting at 18.2x as of May 6th. In the 19x-20x range, small caps decline about 64% of the time over the next 12 months, for an average drop of 2%. In the 18-19x range, small caps have historically risen on a 12 month forward basis 64% of the time, but the average gain is 4%

Importantly, even though many individual growth stocks have been hit much harder, the Russell 2000 itself was only down 9.2% from its early March 2014 peak as of the May 8th close. While this move has felt painful to many investors, it is important to keep in mind that since the mid 1990′s the average and median pullbacks in the Russell 2000 have been 21% and 14%. Given the historical track record, we would not be surprised to see the Russell 2000 approach 1,000 (compared to its peak of 1,209 and recent close of 1,097) before a bottom is found.

The iShares Russell 2000 ETF (IWM) has dropped 5.2% so far this year, while Mueller Industries (MLI), which has plunged 55%, Medidata Solutions (MDSO), which has plummeted 44%, Financial Engines (FNGN), which has slid 42%, and Isis Pharmaceuticals (ISIS), which has tumbled 42%, are the index’s biggest losers.