Small-Cap Potential Shines in 2024 Small-Cap Potential Shines in 2024

By: Alex Freidmen

Despite the roaring success of the Nasdaq 100 Index in 2023, driven by tech giants like Microsoft and Meta Platforms, astute investors are casting their gaze to other corners of the market. As we delve into the annals of financial history, it becomes evident that market dynamics are ever-changing. In 2021, large-cap stocks took the spotlight; 2022 saw the rise of commodities, and 2023 was the year for growth stocks. Now, the burning question is– are small-cap stocks the dark horses of 2024?

Potential Reversion to the Mean

Until the Russell 200 Index achieved fresh 52-week highs late last year, the index endured a drought of over 500 days without reaching a new high–a record more dire than that of the Internet Bubble and the Global Financial Crisis. This significant underperformance has set the stage for a potential reversion to the mean trade, reflecting an opportunity for the asset’s price to revert back to its historical average.

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Image Source: SentimenTrader, Russell Investments

Strength Begets Strength

The Russell 2000 notched a remarkable 21.9% gain in the final two months of 2023–one of its most robust two-month performances ever. Historical data since 1982 revealed that whenever the Russell 2000 experienced gains exceeding 18.5%, it was higher six months later, with an average gain of 19.2%. The numbers don’t lie–the odds are in favor of the trade.

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Image Source: Ryan Detrick, Carson Research

Technical Set Up

After three consecutive weeks of decline, the Russell 2000 Index ETF is edging towards an attractive reward-to-risk zone, marking the first pullback to its 10-week moving average.

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Image Source: TradingView

Dovish Fed Favors Small Caps

According to the CME Group’s FedWatch tool, market participants anticipate six interest rate cuts in 2024. Lower interest rates spell good news for small-cap stocks as they lower the cost of borrowing for businesses. Small-cap companies often rely on loans to fund their operations and expansion; thus, reduced interest rates translate to more affordable capital, leading to lower interest expenses and improved profit margins.

Bottom Line

While mega-cap tech stocks have been the darlings of 2023, 2024 might very well usher in a new reign for small-cap stocks. The evidence is mounting in their favor, bolstered by prospects for reversion to the mean, momentum signals, and a tantalizing high reward-to-risk technical zone.