Analysis: Micro-cap stock surge shows investor risk taking, GameStop effect

Lewis Krauskopf
·4 min read
A GameStop store is seen in the Jackson Heights neighborhood of New York City

By Lewis Krauskopf

NEW YORK (Reuters) - Some of the biggest winners on U.S. stock exchanges so far this year have been their smallest members, partly fueled by the GameStop effect, but their gains could be particularly vulnerable if investors get skittish about equities.

The Russell Microcap index, whose components have a median market value of about $350 million, has climbed 26% nearly two months into 2021. That gain tops the 4.5% rise for the large-cap S&P 500, whose components' median market value is about $28 billion, and the performance of benchmark small- and mid-cap stock indexes.

The micro-cap gauge ceded some gains during volatility earlier this week while other indexes held up better. With relatively few shares available to be traded, micro-cap stocks favored by individual investors could be hit hard in a downturn.

“Because they are retail oriented, they are probably going to be a little more vulnerable with the risk-off days versus the risk-on days,” said Chuck Carlson, chief executive officer at Horizon Investment Services.

Shares of smaller U.S.-based companies, which tend to rely more on domestic business, are generally benefiting from hopes for a rebounding U.S. economy fueled by widespread vaccinations. That economic optimism also lifted micro-cap stocks, according to investors, after the group long underperformed until last year.

A "speculative fever," as one investor put it, symbolized in wild swings of GameStop Corp shares, also could be fueling micro caps.

GameStop shares doubled on Wednesday, lifting their year-to-date gain to over 380% and the video game chain's market value to $6.4 billion. That puts GameStop, whose shares are in the iShares Micro-Cap ETF, above the value of some S&P 500 companies.

There has been a "fundamental basis" supporting micro caps' strong performance, said Walter Todd, chief investment officer at Greenwood Capital. But, he added, "historically you would say that is one of the riskier parts of the market and the fact that it has moved so aggressively ... is emblematic of high risk appetite.”

More than 80% of the components of the iShares Micro-Cap ETF had posted gains in 2021 as of Tuesday, against over 60% of those in the SPDR S&P 500 ETF, according to Refintiv data.

Among stocks on the New York Stock Exchange and Nasdaq, those that started the year with market values of less than $500 million were up an average 34%, triple the gain of those above $500 million, according to Refinitiv data.

Big micro-cap gains this year include a 177% rise for shares of Esports Entertainment Group and a 178% surge for Energous Corp, a wireless charging company.

"The speculative fever is out there," said Eric Kuby, chief investment officer at North Star Investment Management, which has run a micro-cap fund for over 20 years. As long as that persists, he said, "it’s good for this class of stocks that are speculative in their nature."

Since Pfizer's breakthrough COVID-19 vaccine news in early November, the Russell Microcap index has soared 54% against a nearly 12% rise for the S&P 500.

Until then, the micro-cap index had fallen 2% in 2020 against the S&P 500's nearly 9% rise, after lagging the S&P in the prior three years.

“You are coming out of this incredibly long period of historic underperformance going into the pandemic,” Kuby said. “One could argue after that period of underperformance, a lot of them had gotten very inexpensive.”

Small-cap funds, which include micro caps, have seen nearly $23 billion in net inflows starting in November after six months of outflows, according to Lipper data.

“They are cheap stocks, they are getting fund flows, they fit some of the themes that I think people are interested in,” said Steven DeSanctis, equity strategist at Jefferies.

Investors noted that money flowing to micro-cap stocks can create outsized moves because they have relatively few shares available to be traded. Micro-cap stocks have an average free float of about 29 million shares compared with an average of about 600 million shares for S&P 500 stocks, according to Refinitiv data.

“Micro caps are particularly unpredictable," said Joel Schneider, deputy head of portfolio management at Dimensional, "but they do go through periods of very strong performance.”

(Reporting by Lewis Krauskopf; Editing by Megan Davies and Steve Orlofsky)