On 6 October 2022, Shares wrote that it was time to start looking at small cap stocks again. The timing was impeccable, with this part of the market having perked up only a few weeks later.

In the UK small cap investment trust space, Rockwood Strategic (RKW) has risen by 39% in value since our October article, while Montanaro UK Smaller Companies (MTU) is up 25%. 

We argued that valuations were compelling and that historically, UK smaller companies have outperformed larger stocks over time. The fact many share prices in this space have since moved up will be of great relief to retail investors given small caps suffered such dramatic falls in early 2022.

This isn’t the only area of the market on the move. Many of the big US-listed stocks which had an awful time on the stock market last year are rebounding fast. For example, Tesla (TSLA:NASDAQ) is up 65% so far this year. Facebook-owned Meta Platforms (META:NASDAQ) jumped by 22% in January.

Bitcoin is also staging a comeback, advancing 40% over the past month alone. When the frothier end of the market is jumping, you must start asking questions why investor sentiment has improved.

Firstly, many people believe we’re close to the peak in this cycle for interest rate rises. That’s led to a rotation away from defensive stocks in recent months to more of a ‘risk-on’ trade. Secondly, there are hopes that the looming recession won’t be as devastating as experts previously thought.

Earnings misses, cautious outlook statements by management, downgraded earnings forecasts – many of these bits of bad news are seemingly being ignored by the market. That is something to watch. It stokes the argument that we may be in a bear market rally, rather than the start of a sustained recovery.

A bear market is when share prices fall 20% or more from recent highs amid investor pessimism typically linked to concerns about the economy, monetary policy or geopolitics. A bear market rally is a description for a sharp, short-term rebound in share prices despite a continuation of the difficult backdrop.

Bloomberg says there have been 20 bear-market rallies in the US S&P 500 index bigger than 15% since 1927. Some of these rallies lasted about 30 to 50 days, but one ran for 393 days. At the time of writing, the FTSE 100 index in the UK and the S&P 500 were both trading approximately 14% higher than their October 2022 lows.

The Federal Reserve was expected to have put up US interest rates as this issue of Shares was being prepared for distribution, while the Bank of England could do the same today (2 February). The scale of any rate hikes and associated commentary could play an important role in deciding where the market goes next. It’s great to see share prices moving higher, just don’t assume it will always be this easy to make money.

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