Small stocks have had a rocky start to 2024 so far, but they can still shine through the rest of this year, according to Tom Lee, a stock bull and head of research at Fundstrat Global Advisors.
Lee expects the large-cap S&P 500 SPX to rise to 5,200 points by the end of this year, more than 7% above its current level. But he also expects a Russell 2000 RUT,
A measure of small-cap stocks, it will reach 3,000 points by the end of 2024. This is more than 50% higher than the index's current level.
is reading: Small-cap stocks that took a beating are back on the rise. Why could it rise in 2024?
Small stocks have had a mostly dull 2023 due to rising interest rates and the risk of a recession. However, they got a boost in the fourth quarter, driven by optimism that the Fed may start cutting interest rates soon.
However, those expectations have since been dampened by better-than-expected economic data and some hawkish comments from Fed officials in the new year. In turn, traders are now reducing their expectations about when interest rate cuts could begin.
The Russell 2000 is down 2.8% in 2024 so far, while the S&P 500 is up 1.7% over the same period, according to FactSet data.
However, the case for a small-cap rally this year remains, according to Fundstrat's Lee, who said small-cap stocks remain his favorite sector for 2024.
The price-to-book ratio of the companies that make up the Russell 2000 is just 44% of the S&P 500, suggesting that small-cap stocks are still significantly discounted, Lee wrote in a note on Monday.
This ratio saw the same level in 1999, after which the iShares Russell 2000 ETF MX:IWM began outperforming the SPDR S&P 500 ETF Trust SPY for 12 years, according to Lee.
While penny stocks are currently seeing outflows from investors, Lee believes “inflows will be positive for the full year in 2024,” which should boost prices.
Meanwhile, once the Fed starts lowering interest rates, investors will likely start withdrawing money from money markets, which now offer returns of up to 5%, to invest in other assets such as stocks.
Jill Carey Hall and Nicholas 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 outperform their large-cap counterparts since 2016.
Small stocks have historically outperformed in the wake of a narrow-based market, as the BofA Global team noted — and 2023 was a “record year for bad breadth,” with the stock market rally driven in particular by a select few mega-cap technology stocks.
Meanwhile, based on historical data, small-cap stocks tend to deliver double-digit returns and outperform their large-cap counterparts during election years, analysts added.
The Dow Jones Industrial Average (DJIA) fell on Tuesday after hitting an all-time high on Monday. The S&P 500 and Russell 2000 indexes rose on Tuesday, according to FactSet data.
