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Small-cap Opportunity in 24' (Watch these 5 Catalysts)
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Over the past five years, small-cap stocks and the Russell 2000 Index ((IWM - Free Report) ) have underperformed the other major U.S. equity indices. For example, despite the black swan event of the COVID-19 pandemic of 2020 and the volatile and brutal bear market of 2022, the S&P 500 Index ETF ((SPY - Free Report) ) has gained an impressive 85% while the tech-heavy Nasdaq 100 Index ETF ((QQQ - Free Report) ) packed on gains of 147%! Meanwhile, the Russell 2000 Index continues to be in a long and deep drawdown off its all-time highs and is only up a feeble 37% over the same period. A “hawkish” Federal Reserve monetary policy coupled with outsized exposure to the ailing commercial real estate has caused the dramatic underperformance.
After five years of underperformance, investors are looking elsewhere for performance, piling into tech stocks, and avoiding “throwing good money” after bad. While the small-cap trade may be counterintuitive, five data points suggest that it may provide the most signficant profit potential into year-end, including:
Sentiment: Bet on the “Redheaded Step Child”
Savvy investors find success by zigging while the crowd zags. According to data from Bank of America ((BAC - Free Report) ), small-cap stocks represent just 3% of active portfolios, half the weight compared to decade ago.
Image Source: Bank of America
Interest Rate Cuts: Follow the Money, Not Opinions
Last month, Fed Chair Jerome Powell had a surprisingly “dovish” attitude when discussing interest rates, saying that the U.S. central bank is “not from reaching its goal” (2% inflation rate). Despite Powell’s statement, many investors still doubt that the Fed will cut rates in 2024.
Rather than guessing or trusting my gut feeling, I prefer to follow the money. The CME FedWatch Tool calculates probabilities of interest rate moves based on trading in federal funds futures contracts. In other words, what real money is betting on, not opinions. Currently, the FedWatch Tool is pricing in five rate cuts before year-end (and gives a 90+% chance for at least three to occur). Lower interest rates are bullish for small caps because they reduce borrowing costs, stimulate economic activity, and potentially increase profitability for smaller, more growth-oriented companies.
Growth at a Reasonable Price
Russell 2000 stocks are cheaper than S&P 500 stocks from a price-to-book perspective, yet are slated to grow faster in 2024.
Image Source: Zacks Investment Research
Relative Strength & Base Breakout
Over the past month, IWM has exhibited relative strength versus QQQ. With tech stocks like Nvidia ((NVDA - Free Report) ) up for eleven weeks in a row, now may be the time for some rotation into other market areas. Furthermore, IWM is breaking out of a perfect cup-with-handle base structure. The base structure is part of a more extended base that dates back two years! As the old Wall Street adage goes, “The longer the base, the higher in space.”
Image Source: TradingView
Stabilization in Regional Banks & CRE
Time is the ultimate healer. After a group of investors rescued regional bank New York Community Bancorp ((NYCB - Free Report) ), there is much less risk in the regional banking space. This observation is important for investors as the small-cap space is heavily weighted toward financials. In addition, the further away Wall Street gets from the pandemic-induced commercial real estate crisis, the less impact it will have on small caps and the general market.
Bottom Line
There are several compelling reasons for investors to reconsider when it comes to small-caps. Federal Reserve policy and poor sentiment are just a few factors that should drive these stocks in 2024.
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Small-cap Opportunity in 24' (Watch these 5 Catalysts)
Over the past five years, small-cap stocks and the Russell 2000 Index ((IWM - Free Report) ) have underperformed the other major U.S. equity indices. For example, despite the black swan event of the COVID-19 pandemic of 2020 and the volatile and brutal bear market of 2022, the S&P 500 Index ETF ((SPY - Free Report) ) has gained an impressive 85% while the tech-heavy Nasdaq 100 Index ETF ((QQQ - Free Report) ) packed on gains of 147%! Meanwhile, the Russell 2000 Index continues to be in a long and deep drawdown off its all-time highs and is only up a feeble 37% over the same period. A “hawkish” Federal Reserve monetary policy coupled with outsized exposure to the ailing commercial real estate has caused the dramatic underperformance.
After five years of underperformance, investors are looking elsewhere for performance, piling into tech stocks, and avoiding “throwing good money” after bad. While the small-cap trade may be counterintuitive, five data points suggest that it may provide the most signficant profit potential into year-end, including:
Sentiment: Bet on the “Redheaded Step Child”
Savvy investors find success by zigging while the crowd zags. According to data from Bank of America ((BAC - Free Report) ), small-cap stocks represent just 3% of active portfolios, half the weight compared to decade ago.
Image Source: Bank of America
Interest Rate Cuts: Follow the Money, Not Opinions
Last month, Fed Chair Jerome Powell had a surprisingly “dovish” attitude when discussing interest rates, saying that the U.S. central bank is “not from reaching its goal” (2% inflation rate). Despite Powell’s statement, many investors still doubt that the Fed will cut rates in 2024.
Rather than guessing or trusting my gut feeling, I prefer to follow the money. The CME FedWatch Tool calculates probabilities of interest rate moves based on trading in federal funds futures contracts. In other words, what real money is betting on, not opinions. Currently, the FedWatch Tool is pricing in five rate cuts before year-end (and gives a 90+% chance for at least three to occur). Lower interest rates are bullish for small caps because they reduce borrowing costs, stimulate economic activity, and potentially increase profitability for smaller, more growth-oriented companies.
Growth at a Reasonable Price
Russell 2000 stocks are cheaper than S&P 500 stocks from a price-to-book perspective, yet are slated to grow faster in 2024.
Image Source: Zacks Investment Research
Relative Strength & Base Breakout
Over the past month, IWM has exhibited relative strength versus QQQ. With tech stocks like Nvidia ((NVDA - Free Report) ) up for eleven weeks in a row, now may be the time for some rotation into other market areas. Furthermore, IWM is breaking out of a perfect cup-with-handle base structure. The base structure is part of a more extended base that dates back two years! As the old Wall Street adage goes, “The longer the base, the higher in space.”
Image Source: TradingView
Stabilization in Regional Banks & CRE
Time is the ultimate healer. After a group of investors rescued regional bank New York Community Bancorp ((NYCB - Free Report) ), there is much less risk in the regional banking space. This observation is important for investors as the small-cap space is heavily weighted toward financials. In addition, the further away Wall Street gets from the pandemic-induced commercial real estate crisis, the less impact it will have on small caps and the general market.
Bottom Line
There are several compelling reasons for investors to reconsider when it comes to small-caps. Federal Reserve policy and poor sentiment are just a few factors that should drive these stocks in 2024.