The increasing likelihood of a Fed interest rate cut, following Fed Chairman Jerome Powell’s speech at the Jackson Hole Economic Policy Symposium on Aug. 22, and investors rotating into sectors beyond tech, make small-cap stocks appear well-positioned for a comeback. Growing expectations of broader market strength among strategists also paint a better picture for small-cap stocks.

The Russell 2000 Index, a benchmark for small-cap U.S. stocks, has surged around 3.1% since last Friday, following Fed Chair Jerome Powell’s comment. August has been particularly strong for the index, which is up nearly 8.9% so far, prompting strategists to revise their outlook on small-cap stocks.

Wall Street Rethinks Small-Cap Potential

Analysts and economists are revising their outlook on small-cap stocks. Truist Wealth co-chief investment officer, Keith Lerner, upgraded his view on small-cap U.S. stocks from less attractive to neutral, as quoted on MSN.

Per BofA equity strategist Jill Carey Hall, as quoted on MSN, the Russell 2000 is expected to outperform the large-cap stocks in the near term. UBS strategists also share the same view, forecasting that small-cap and low-quality stocks may extend gains as lower rates help relieve balance sheet pressures.

Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, believes that the small-cap stocks could be well-positioned to experience gains in the near term, supported by investor sector rotation away from large tech companies, as quoted on MSN.

Rate Cut Hopes Spark Fresh Momentum

Expectations of an interest rate cut in September grew after Powell’s comments last Friday. Per the CME FedWatch tool, markets are anticipating an 87.2% likelihood of a rate cut in September, marking an increase from 75% before Powell’s Jackson Hole speech.

Markets also estimate a 93.8% likelihood of a rate cut in October and a 98.8% likelihood of a rate cut in December, according to the CME FedWatch tool. Historically, small-cap stocks tend to perform well following rate cuts by the Fed.

Being heavily dependent on external borrowings, small-cap stocks could massively benefit from lower interest rates, which could increase their capital availability. Reduced rates also allow these companies to refinance existing debt at a cheaper rate, enabling them to invest in growth and expansion.

Upbeat Forecasts Signal Market Strength Ahead

As small-cap companies are more domestically tied, they are poised to outperform when the economy improves. Market sentiment has been improving, with Jefferies, UBS, Citigroup and HSBC recently upgrading their S&P 500 forecasts, citing the economy’s upbeat outlook driven by resilient earnings and a supportive macro backdrop.

According to Nancy Lazar, chief global economist at Piper Sandler, as quoted on MSN, the economy is expected to rebound from the current slowdown. She anticipates that rate cuts, along with the tax-cut bill and deregulation, will help accelerate the economy next year, resulting in growth of 3%.

ETFs to Consider

Below, we highlight a few funds that investors can consider to gain increased exposure to the small-cap space.

Investors can consider iShares Core S&P Small-Cap ETF (IJR Quick QuoteIJR - Free Report) , iShares Russell 2000 ETF (IWM Quick QuoteIWM - Free Report) , Vanguard Small Cap ETF (VB Quick QuoteVB - Free Report) , Schwab U.S. Small-Cap ETF (SCHA Quick QuoteSCHA - Free Report) and SPDR Portfolio S&P 600 Small Cap ETF (SPSM Quick QuoteSPSM - Free Report) .

With a one-month average trading volume of 34.78 million shares, IWM is the most liquid option, ideal for active trading strategies. Regarding annual fees, SPSM is the cheapest option among the other mentioned funds, charging 0.03%, which makes it more suitable for long-term investing.

IJR has also gathered an asset base of $85.35 billion, the largest among the other options. Performance-wise, VB outpaced other funds, gaining 1.85% over the past month and 5.06% over the past year.