Many investors expected small-cap stocks to outperform in 2024, saying the prospect of easing monetary policy introduced by Federal Reserve Chairman Jerome Powell late last year would be a boon for the rate-sensitive category. Instead, small caps spent the first half of this year doing what they’ve done for the past decade: lagging. While the S&P 500 soared to all-time highs this year on the strength of a handful of AI stocks, the small-cap Russell 2000 has spent the past six months treading water. But now, there finally seems to be an outbreak. In July, the Russell 2000 rallied more than 9%. Meanwhile, the S&P 500 is flat on the month. .RUT YTD mountain Russell 2000 year to date An improvement in the outlook for interest rates, as well as inflation, fueled the small-cap rally as investors bet on the asset class like they haven’t in a long time. These investors expect a historically wide valuation gap, rebounding M&A activity and long-term renewal trends to support a multi-year turnaround in performance for the asset class. “That clear just tells me that you’re finally going to get some sane investors back into the markets,” said Nicholas Galluccio, portfolio manager at Teton Advisors. The manager said his fund, the TW Smallcap Equity Fund Class I, rose with the market. As of Wednesday, it was up 11.37% this year. The Russell 2000 Value rose 10%, with the Russell 2000 gaining 11%. A Sustained Rally Small-caps have underperformed for about the last decade, but have typically done better historically. An often-cited stock pricing model is the French Fama 3-factor model, which found that since 1927, small caps have outperformed large caps by two percentage points each year. “It’s been a tough run for small caps. You’ve seen the ‘Magnificent Seven’ suck all the air out of the room, both in terms of attention, but also in terms of investor flows into the asset class. analysts I’ve seen say this is the longest period of underperformance,” said Mike Rode of American Century Investments. But Rode added, “It’s cyclical over time, though.” Rode expects that outperformance could last for some time, anywhere from a 12- to 24-month period. Meanwhile, Teton Westwood believes it can last much longer. “I think small caps will perform better for the next three years,” said Galluccio But there are other reasons to add to the small-cap bull case.The integration of overseas supply chains amid rising geopolitical tensions — particularly for semiconductors and pharmaceuticals — is expected to support the typically domestically focused small caps. . As an example, Rode pointed out that an electric vehicle battery plant for Panasonic in De Soto, Kansas, can boost the bottom line for small-cap companies contracted to build buildings and roads, as well as regional banks that help finance them. of the projects. SUM YTD mountain Summit Materials year to date Summit Materials , a construction materials company, is one such stock that can benefit from upgrade projects. The stock is up just 2% this year. Analysts polled by LSEG see it as a buy. Similarly, Teton Westwood’s Galluccio is invested in wafer manager Cohu, which he said is cheap, has earnings power, no debt and plenty of cash on its balance sheet. “Those are the kinds of companies we’re looking at,” he said. Cohu shares are down roughly 10% this year, but the stock is considered a buy, according to LSEG’s consensus estimate. COHU YTD mountain Cohu stock year-to-date Other trends expected to boost small-caps include a steepening yield curve, as well as a pick-up in M&A activity. There is inherent risk in small-cap investments, as they are less liquid and more tied to the economy than large-cap peers. However, investors can try to avoid these pitfalls by investing in quality companies with strong balance sheets and high returns on capital. “The last decade has been the first time in many, many years that small-caps have underperformed, prompting pundits to say that quality, quality, quality is large-cap growth. Well, guess what? Quality can also be small-cap,” Galluccio said.
