Microcap stock mania to start 2021 is a signal of more gains, and potential danger, ahead

Published Fri, Jan 15 20211:18 PM EST

The search for market excesses can probably start small – in fact with the smallest stocks that have seen outsized gains so far in 2021 as well as record trading volumes. Already in 2021, companies with a market capitalization between $50 million and $300 million, as measured by the Russell Microcap index , are on a tear. The group has risen just shy of 10% with January only half over, part of a 12-month trend that has seen the gauge soar 31%. In fact, the gains so far this year have set a record for the index that goes back to 2007. The short history of the Russell microcap measure suggest that the profits will continue, according to Bespoke Investment Group. Years in which the index has risen at least 3% in the first seven trading days have seen full-year gains ranging from 11.9% to 38.5%. For all years, the group has seen a median increase of 11.6% and it has registered positive numbers 64% of the time. Reasons for the growth are varied, from individual company stories to the trend of money looking for a place to go during volatile times. Many of the names in the space that have seen big share price appreciation have piggy-backed off high-flying tech stocks, as the Nasdaq Composite actually has performed even better than micro caps over the 12-month span. One other reason, though, is that the companies generally trade at low prices or volume and many aren't even listed on the major exchanges. They instead trade over the counter, through the pink sheet listing. They thus are subject to rapid swings in their prices, providing the opportunity for fast gains at often cheap prices. The companies with the biggest weighting on the iShares Microcap ETF, which tracks the Russell index, are mostly on the higher-priced side, but trade on generally low volume and have seen some eye-popping returns. They include Fuelcell Energy (up 57.6% year to date and 746% over the past 12 months), Digital Turbine (6% and 698.6% respectively), Intellia Therapeutics (53.1%, 473.7%), Magnite (1.4%, 189.4%) and Workhorse Group (24.4%, 572.4%). Such returns have been especially alluring to the crop of new, young traders using low-cost platforms such as Robinhood and trading tips over Twitter and other social media sites. Market veterans worry about what's on the other side after the mania ends. Herd mentality "There's a cohort of investors that are navigating the investment process in a different fashion that the herd mentality and the combination of Robinhood and social media can give you," said Art Hogan, chief market strategist at National Holdings. "This new cohort seems to be finding this pattern of finding the flavor of the day and getting it ramped up and hasn't really gone through a down cycle. While it doesn't take much to move these things up, it doesn't take much for them to collapse, either." Indeed, the group fell faster than the rest of the market Friday , with the IWC ETF trading down 1.5% around midday as other averages were down considerably less. That herd mentality of which Hogan spoke has manifested itself in a variety of ways. When Tesla founder Elon Musk tweeted last week for his followers to use messaging app Signal , traders misinterpreted and piled into Signal Advance . The over-the-counter stock saw its share price skyrocket 527% that day. Shares have fallen in recent days but still remain well above their level before the episode, even though traders bought the wrong company. The rise in micro caps has come around the same time as investors have piled into bitcoin , and as concerns have been raised about market valuations in general. However, Hogan doesn't see the rise in the smaller, more volatile companies as signs of larger danger in the market. "There's obviously an inherent danger of irrational investing that the current cohort of retail investors just hasn't seen the negative side of yet, and that will come," he said. "I don't think I interpret it as a broader irrational exuberance in the market. The reflation trade with the economically sensitive names makes sense right now."

The Charging Bull bronze sculpture located on Broadway at the Financial District of Manhattan.

Nicolas Economou | NurPhoto | Getty Images

The search for market excesses can probably start small – in fact with the smallest stocks that have seen outsized gains so far in 2021 as well as record trading volumes.

Already in 2021, companies with a market capitalization between $50 million and $300 million, as measured by the Russell Microcap index, are on a tear. The group has risen just shy of 10% with January only half over, part of a 12-month trend that has seen the gauge soar 31%.