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The small-capitalization comeback has yet to ease off its torrid pace, although there are some signals suggesting investors should treat smaller stocks with caution.
In both Canada and the United States, market conditions have been favourable for stocks of all sizes ever since the last correction hit its nadir in the winter. But small caps have been on a tear, outperforming basic indexes by a wide margin.
Those gains have been fuelled by a revival of risk appetite in general and renewed interest in commodities, which has had particular relevance for the Canadian market.
The rest of this year, however, is not likely to be as conducive to commodity gains as has the year to date, according to Barclays.
"Much of the investor demand this year been tactical and, unless the asset class continues to generate strong returns in the second half, then outflows could resume," Barclays analyst Kevin Norrish said in a report dated Aug. 4.
"Our price forecasts for key commodities like copper and oil suggest a flat to negative second half of the year."
Canada's resource concentration is even more pronounced than in the broader market, making the small-cap space highly susceptible to commodity fluctuations.
So the global downturn in commodity prices brought about a brutal, all-consuming sell-off in Canadian small caps spread over several years. The S&P/TSX small-cap index fell by nearly 50 per cent over about five years up to last January.
From those lows, gold and oil prices bounced back sharply, drawing investors back into the commodity space. Investment inflows into commodities have exceed $50-billion (U.S.) this year so far, which is the highest figure since 2009, when commodity assets were at the outset of a three-year boom, according to the Barclays report.
Canadian small-cap stocks have flourished as a result. The S&P/TSX small-cap index has risen by 54 per cent since mid-January, when the index was at its lowest level since mid-2009. Even within the large-cap S&P/TSX composite index, investors have gravitated toward smaller stocks.
There is no doubt of the influence of commodities on the small-cap rally. Of the top 50 performing stocks within the Canadian small-cap index since January's bottom, there are a mere four non-resource names.
Commodity prices, however, have a habit of performing well in the first half of the year and "collapsing" in the second half, Mr. Norrish said.
"A loss of enthusiasm for being on the long side of commodity investments is already apparent," he wrote.
"It is perhaps telling that those net long positions have already started contracting quite rapidly both in overall terms and as a share of the market."
Recent strength in U.S. small caps, meanwhile, has coincided with an improvement in investor sentiment since the global sell-off this winter. Smaller stocks, which on average are considered to be riskier than their larger counterparts, are one asset class that tends to benefit from rising risk appetite.
Smaller companies also tend to be more domestically focused, so encouraging readings for the U.S. economy, such as Friday's employment figures, typically benefit small-cap stocks disproportionately.
The Russell 2000 small-cap index has outperformed the broader market as a result, having risen by 30 per cent from the trough in January. That run has pushed trading multiples up to unattractive levels, said Ed Lugo, a small-cap fund manager at Franklin Templeton Investments.
"It's just getting a bit pricey," he said. "Health care is still too expensive, technology is too expensive. We've been finding some opportunities in financials. Not much elsewhere."
Steven DeSanctis, a strategist at Jefferies, said on a blog run by index compiler FTSE Russell that he remains cautious about U.S. small caps.
"Absolute valuations are stretched, earnings growth continues to be weak, and volatility may increase due to the upcoming U.S. election, possible U.S. Fed policy moves and continued investor concerns around Brexit."
Tim Shufelt