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Investors Ignore Record Small Cap Rally

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“What if a major stock index jumped to an all-time high, but most investors didn’t notice?”

An important question asked and answered by The Wall Street Journal’s Jonathan Cheng. Cheng notes small cap stocks, as measured by the Russell 2000 index, are experiencing just that.

The broad market index of smaller U.S. companies is up an “eye-popping” 36% since early October, and just 4.2% below the record high of 865.29 hit last April. Traditionally more volatile than large cap blue chips, the sector is following the Dow Jones Industrial Average’s recent rally, which broke the 13,000 barrier Tuesday for the first time since 2008.

Maybe it’s investor fatigue over market volatility of the past few years, or more of a focus on asset protection; whatever the reason, the Russell’s record run has had “a tough time attracting new believers in small-cap stocks,” according to Cheng.

“Since May [2011], individual investors have yanked money from U.S. small-cap mutual funds in 37 of 40 weeks,” he writes, citing according EPFR Global. “U.S. small-cap mutual funds have suffered an exodus of $15.9 billion since the end of April, according to Morningstar. Assets at U.S. small-cap exchange-traded funds are down by $4.4 billion.”

So what explains the Russell 2000′s ascent?

“As with other U.S. stock classes, few investors these days are actively trading small-cap stocks, which typically have a market value of about $2 billion or less. Trading volumes on Wall Street have been light for months, hedge funds and investment banks have pared down their trading operations, and the small investors that exited the market after the 2008 financial crisis are hesitant to jump back in–least of all to the riskier small stocks that make up the Russell,” he writes.

As a result, he adds, the few remaining investors and traders are having an outsize impact on small-cap share prices amid the recent improvement in the U.S. economy.

“Prices for small-cap stocks tend to move more dramatically than larger stocks, in part because they are smaller, less liquid and more sensitive to changes in economic performance. So the market’s overall rise has been especially good for small stocks,” he writes. “Smaller companies also are generally less exposed to Europe’s debt crisis and fears of a sharp slowdown in China.”