Small-caps have been on tear ever since the second day of Federal Reserve Chair Jerome Powell’s Congressional testimony when he chose to adopt a dovish tone, and a market strategist said on Monday that the rally in the space is only getting started.
What Happened: The rally seen in the current leg-up will likely be larger than the upside seen in the October-December period, said Fundstrat’s Head of Research Tom Lee in an interview with CNBC. During the eight-week period late last year, the Russell 2,000 Index, a small caps-focused index, rose nearly 30%, he noted.
This time around, institutions are holding a larger short position in small caps and these stocks are even more oversold, Lee said. The median price-earnings multiple of small-caps is now 10 times the estimated earnings for 2025, or even lower, he added.
“So we think that this move could be something like 10 weeks and as much as 40%,” Lee said, adding that, “I think it is just starting.”
Delving into the reason for the reversal in sentiment toward small-cap stocks, Lee noted that the June consumer price inflation was so “astonishingly soft.” “I think it's giving the green light for small caps to rally finally because the Fed will you know ultimately cut hopefully by September,” he added.
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Why It’s Important: The iShares Russell 2000 ETF IWM, an exchange-traded fund that tracks the performance of the Russell 2,000 Index, has gained 8.8% so far this year compared to the roughly 19% gain for the SPDR S&P 500 ETF Trust SPY for the same period.
Incidentally, before the start of the year, Deepwater Asset Management’s Gene Munster predicted that 2024 will likely see the IWM outperforming the SPY. “Sub-$20 billion tech companies are poised to outperform large-cap companies,” he added.
This has sort of ring true over the past few sessions. Since July 5, the IWM has gained 8.1%, while the SPY has added a more modest 1.2%. The buoyancy seen in the small-cap space is due to the fact that most of these companies are reliant on debt for running operations. The anticipated Fed rate cut will likely reduce the cost of debt and also make it easy to tap further into the debt market.
The catch-up by small-caps is also important for the broader market rally, which has so far relied on some heavy-weighted mega-cap techs. The sustenance of the uptrend, analysts say, hinges on the broadening out of the rally.
IWM ended Monday’s session up 1.90% at $217.19, according to Benzinga Pro data.
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