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In the first half of 2023, U.S. small-cap stocks showed decent trends but lagged the S&P 500 (up about 16%) and Nasdaq Composite (up about 31.7%). The small-cap Russell 2000, an index tracking U.S. small-cap stocks, saw modest gains of around 7.2% during that period.
But Wall Street has seen a surge in small-cap stocks lately, with the Russell 2000 index climbing over 10.7% in the past one month versus 5.5% gains in the S&P 500 and 6.1% uptick in the Nasdaq Composite. This rally coincides with cooling inflation data and hopes for Fed rate cuts in 2024.
Below, we highlight a few reasons why small-cap stocks should soar higher in the coming days.
Decent U.S. GDP Growth
The U.S. economy expanded an annualized 4.9% in the third quarter of 2023, the maximum since the last quarter of 2021, above market forecasts of 4.3% and a 2.1% expansion in Q2, the advance estimate showed, per tradingeconomics. Consumer spending grew 4%, the most since Q4 of 2021, thanks to consumption of housing and utilities, health care, financial services and insurance, food services and accommodations and nondurable goods (led by prescription drugs), recreational goods and vehicles.
A Less-Hawkish Fed Going Forward
The latest datapoints indicate that inflation is on the decline. This may cause a less-hawkish Fed in the near term. Market indicators showed a about 97.7% probability that the Federal Reserve would keep interest rates unchanged at 525-550 bps in December, as reflected in data from the CME Group. There is even 52.7% chance of a 25-bp rate cut by March 2024.
Cheaper Valuation of Small-Caps
Eric Green, CIO of Penn Capital Management, suggests that the latest rally in small-caps has been long overdue, given the prolonged outperformance of large-cap stocks, as quoted on Yahoo Finance. Valuations for small-cap companies have become compressed relative to their larger counterparts, making them an attractive option for investors.
Small-Caps: Key Beneficiary of Likely Fed Rate Cuts in 2024
Fundstrat's head of research Tom Lee also projects a small-cap rally in 2024, as quoted on Yahoo Finance. Lee indicated that small caps, which have more short-term debt than other companies, could benefit from the cost of capital coming down as the Fed is expected to cut rates in 2024.
M&A Activities to Pick Up In Small-Cap Space?
Apart from reduced inflation, other factors are contributing to the rally in small-cap stocks. Per strategists, seasonality tends to benefit small caps towards the end of the year, making this an opportune time for their growth. Additionally, the valuation gap between large and small-cap companies, as well as private and public markets, suggests that mergers and acquisitions (M&A) activity may pick up. Companies may find it more attractive to acquire smaller, faster-growing firms, taking advantage of the valuation discrepancy.
Still-High Greenback Not a Problem for Small-Caps
The U.S. dollar ETF Invesco DB US Dollar Index Bullish Fund (UUP - Free Report) , though down 1.3% past month, is still up 4.4% so far this year. With small-cap companies being more inclined to the domestic economy and having less foreign exposure, a stronger U.S. dollar is beneficial for the segment. Although we expect the Fed to cut rates in the second half of 2024, the U.S. dollar strength won’t come down suddenly. It would take some time to cool off and thus will support a long-overdue small-cap rally in the near term.
Top-Ranked ETFs in Focus
Against this backdrop, below we highlight a few top-ranked small-cap ETFs (Zacks Rank #2 (Buy)) that could be tapped now.
Vanguard Small-Cap ETF (VB - Free Report) – Up 8.5% past month
Vanguard S&P Small-Cap 600 ETF (VIOO - Free Report) – Up 8.8% past month
iShares Core S&P Small-Cap ETF (IJR - Free Report) – Up 8.7% past month
Vanguard S&P Small-Cap 600 Growth ETF (VIOG - Free Report) – Up 8.0% past month
Invesco S&P SmallCap 600 Pure Growth ETF (RZG - Free Report) – Up 7.6% past month
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Are Small-Cap ETFs Poised to Surge in 2024?
In the first half of 2023, U.S. small-cap stocks showed decent trends but lagged the S&P 500 (up about 16%) and Nasdaq Composite (up about 31.7%). The small-cap Russell 2000, an index tracking U.S. small-cap stocks, saw modest gains of around 7.2% during that period.
But Wall Street has seen a surge in small-cap stocks lately, with the Russell 2000 index climbing over 10.7% in the past one month versus 5.5% gains in the S&P 500 and 6.1% uptick in the Nasdaq Composite. This rally coincides with cooling inflation data and hopes for Fed rate cuts in 2024.
Below, we highlight a few reasons why small-cap stocks should soar higher in the coming days.
Decent U.S. GDP Growth
The U.S. economy expanded an annualized 4.9% in the third quarter of 2023, the maximum since the last quarter of 2021, above market forecasts of 4.3% and a 2.1% expansion in Q2, the advance estimate showed, per tradingeconomics. Consumer spending grew 4%, the most since Q4 of 2021, thanks to consumption of housing and utilities, health care, financial services and insurance, food services and accommodations and nondurable goods (led by prescription drugs), recreational goods and vehicles.
A Less-Hawkish Fed Going Forward
The latest datapoints indicate that inflation is on the decline. This may cause a less-hawkish Fed in the near term. Market indicators showed a about 97.7% probability that the Federal Reserve would keep interest rates unchanged at 525-550 bps in December, as reflected in data from the CME Group. There is even 52.7% chance of a 25-bp rate cut by March 2024.
Cheaper Valuation of Small-Caps
Eric Green, CIO of Penn Capital Management, suggests that the latest rally in small-caps has been long overdue, given the prolonged outperformance of large-cap stocks, as quoted on Yahoo Finance. Valuations for small-cap companies have become compressed relative to their larger counterparts, making them an attractive option for investors.
Small-Caps: Key Beneficiary of Likely Fed Rate Cuts in 2024
Fundstrat's head of research Tom Lee also projects a small-cap rally in 2024, as quoted on Yahoo Finance. Lee indicated that small caps, which have more short-term debt than other companies, could benefit from the cost of capital coming down as the Fed is expected to cut rates in 2024.
M&A Activities to Pick Up In Small-Cap Space?
Apart from reduced inflation, other factors are contributing to the rally in small-cap stocks. Per strategists, seasonality tends to benefit small caps towards the end of the year, making this an opportune time for their growth. Additionally, the valuation gap between large and small-cap companies, as well as private and public markets, suggests that mergers and acquisitions (M&A) activity may pick up. Companies may find it more attractive to acquire smaller, faster-growing firms, taking advantage of the valuation discrepancy.
Still-High Greenback Not a Problem for Small-Caps
The U.S. dollar ETF Invesco DB US Dollar Index Bullish Fund (UUP - Free Report) , though down 1.3% past month, is still up 4.4% so far this year. With small-cap companies being more inclined to the domestic economy and having less foreign exposure, a stronger U.S. dollar is beneficial for the segment. Although we expect the Fed to cut rates in the second half of 2024, the U.S. dollar strength won’t come down suddenly. It would take some time to cool off and thus will support a long-overdue small-cap rally in the near term.
Top-Ranked ETFs in Focus
Against this backdrop, below we highlight a few top-ranked small-cap ETFs (Zacks Rank #2 (Buy)) that could be tapped now.
Vanguard Small-Cap ETF (VB - Free Report) – Up 8.5% past month
Vanguard S&P Small-Cap 600 ETF (VIOO - Free Report) – Up 8.8% past month
iShares Core S&P Small-Cap ETF (IJR - Free Report) – Up 8.7% past month
Vanguard S&P Small-Cap 600 Growth ETF (VIOG - Free Report) – Up 8.0% past month
Invesco S&P SmallCap 600 Pure Growth ETF (RZG - Free Report) – Up 7.6% past month