Small-cap stocks have had a rough start to 2024 so far, but they could still shine over the rest of this year, according to Tom Lee, an equity bull and head of research at Fundstrat Global Advisors.
Lee expects the large-cap benchmark S&P 500
SPX
to rally to 5,200 points by the end of this year, more than 7% above its current level. But he also expects the Russell 2000
RUT,
a small-cap equity gauge, to reach as high as 3,000 points by the end of 2024. That’s more than 50% above the index’s current level.
Read: Beaten-down small-cap stocks are roaring back. Why they could soar in 2024.
Small-cap stocks had a mostly lackluster 2023 troubled by rising interest rates and the risk of a recession. However, they received a lift in the fourth quarter, fueled by optimism that the Federal Reserve may begin cutting interest rates soon.
However, those expectations have since been hindered by better-than-expected economic data and some hawkish comments from the Fed officials in the new year. In turn, traders are now scaling back their expectations for when rate cuts could start.
The Russell 2000 has fallen 2.8% in 2024 to date, while the S&P 500 has climbed 1.7% over the same period, according to FactSet data.
Nevertheless, the case for a small-cap rally this year remains intact, according to Fundstrat’s Lee, who said small-cap stocks remain his favorite sector for 2024.
The price-to-book ratio of the Russell 2000’s constituent companies stands at only 44% of the S&P 500’s, indicating that small-cap stocks are still considerably discounted, Lee wrote in a Monday note.
That ratio saw the same level in 1999, after which point the iShares Russell 2000 ETF
MX:IWM
started to outperform the SPDR S&P 500 ETF Trust
SPY
for 12 years, according to Lee.
While small-cap stocks are currently seeing investor outflows, Lee believes that “inflows will inflect positive for the full year in 2024,” which would boost prices.
Meanwhile, once the Fed begins to cut interest rates, investors will likely begin pulling funds out from money markets, which now provide up to 5% returns, to invest in other assets such as stocks, Lee added.
Jill Carey Hall and Nicolas Woods, strategists at BofA Global Research, share a similarly bullish view on small-caps. In a note last Friday, they wrote that the small-cap leadership seen in the market in the fourth quarter is likely far from over. They expect 2024 to be the first year that small-cap stocks beat their large-cap counterparts since 2016.
Small-cap stocks have historically outperformed following a narrowly led market, the BofA Global team noted — and 2023 was “a record-breaking year for bad breadth,” with the stock-market rally especially driven by a select few megacap tech stocks.
Meanwhile, based on historical data, small-cap stocks tend to see double-digit returns and outperform their large-cap peers during election years, the analysts added.
The Dow Jones Industrial Average
DJIA
traded lower on Tuesday after recording an all-time high on Monday. The S&P 500 and the Russell 2000 both rose on Tuesday, according to FactSet data.
