By Louis Krauskopf
NEW YORK (Reuters) – U.S. small-cap stocks are having a long-awaited moment, lifted by expectations of lower interest rates and improved election prospects for Republican presidential candidate Donald Trump, a proponent of policies seen as beneficial to smaller, domestic companies.
The Russell 2000 index, which focuses on small companies, rose more than 11.5% over five days, the index’s biggest gain in such a period since April 2020.
Meanwhile, technology and growth stocks wobbled, reinforcing the view that small-cap companies have benefited from this year’s biggest winners rotating into unloved corners of the market. The tech-dominated Nasdaq 100 has fallen 3% since last week, including its biggest one-day drop this year on Wednesday. The S&P 500, generally considered a benchmark for large-cap U.S. stocks, rose 0.2%.
“I think the narrative has changed,” said Eric Coby, chief investment officer at Northstar Investment Management, which specializes in small-cap stocks. “I hope this jump in stocks over the past week is just the beginning of a very long period, potentially many years, where small-cap stocks can make big gains.”
For months, small-cap stocks have been stagnant as investors pour money into the big-cap tech stocks that have led the indexes for most of 2024. The Russell 2000 is up just 10.5% this year despite the recent surge, while the S&P 500 is up 17% and the Nasdaq 100 is up about 18%.
Expectations changed last week, when a lower-than-expected inflation reading boosted expectations that the Federal Reserve will cut interest rates in the coming months, a potential boon for small businesses struggling with high borrowing costs.
Higher interest rates have been a “headwind for small-cap companies,” said Jason Swiatek, head of small- and mid-cap equity at Jennison Associates. “On the flip side, as we move into a rate-cutting cycle, that takes some of the pressure off.”
The rally accelerated after a failed assassination attempt over the weekend, which appeared to heighten expectations of a victory for Trump, whose proposals to raise tariffs and cut taxes could benefit small businesses.
Small-cap stocks that have risen since last week’s inflation data include biotech company Caribou Biosciences, which has surged 55% in that time, homebuilder Hovnanian Enterprises, which has risen more than 30%, and insurer Hippo Holdings, which has risen more than 29%.
The expanding turnover of technology stocks — whose run has raised concerns about overvalued valuations and drawn comparisons to the dot-com bubble two decades ago — could boost the strength of small-cap companies.
The Russell 2000’s total market capitalization was last at $2.7 trillion, according to data from the London Stock Exchange. That’s less than the individual market caps of three companies, Microsoft, Apple and Nvidia, each with a market capitalization of more than $2.9 trillion.
“As money flows out of large-cap stocks and looks for a new home, it doesn’t take much to move smaller stocks,” said Peter Toews, president of Chase Investments.
History shows that sharp gains in small-cap companies bode well for their short-term performance. The Russell 2000 gained at least 1% in five straight sessions over the past week, something that has only happened four times before, according to Bespoke Investment Group. After those previous streaks, the index gained an average of 5.9% over the following month, according to Bespoke.
While the S&P 500 has hit record highs all year, the Russell 2000 remains about 8% below its 2021 peak, suggesting that small-cap companies may have room to rise.
Individual investors are also buying. Analysts at Vanda Research said the inflows into small-cap companies have sparked a “short squeeze,” when a high price forces bearish investors to pull out their bets against a stock, pushing it higher.
“We believe there is room for retailers to continue to pursue this trade over the next week or two,” they wrote.
Small-cap investors have been disappointed in periods of strength before. Excitement about the prospect of rate cuts sent the Russell 2000 index up more than 20% between late October and late December 2023, but the index fell earlier this year when the rate cuts failed to materialize.
The earnings season that has now begun could provide more reason for small-cap companies to take a beating, with Russell 2000 companies expected to post an 18% jump in second-quarter earnings, according to LSEG. Large-cap growth companies will also have a chance to regain the lead, with Tesla and Alphabet reporting next week.
Angelo Korkavas, chief investment strategist at brokerage Edward Jones, said the firm has a “neutral” view on small-cap companies while waiting to see if companies can show stronger earnings growth.
To be more bullish on the group in the long term, he said, “We would need to see more evidence that earnings are coming in much better than expected or that economic activity is starting to recover.”
(Reporting by Louis Krauskopf; Additional reporting by Susan McGee; Editing by Ira Iosbashvili and Leslie Adler)