Small-caps ready to take over market leadership, strategists say

investmentnews.com:

Take note, advisors. The market’s Davids are finally taking over from the Goliaths.

The small-cap Russell 2000 index is up 14.5 percent in the past three months, handily outperforming the S&P 500 index by more than 3 percentage points. Given the current valuation disparity between large- and small-cap stocks, the Russell may extend its lead even further in the months ahead. Small-caps are historically cheap on both an absolute and relative basis, trading at 25-year lows relative to large-cap names.

Of course, the market’s whales, led by the so-called Magnificent 7 tech stocks, have been on a phenomenal run compared to its minnows over the past 12 months, with the S&P 500 returning more than 28 percent compared to the Russell 2000’s 8 percent return.

Still, the recent run in small- and microcap stocks has a number of advisors, fund managers and strategists telling their clients that it’s time to think small.

“As the Magnificent Seven becomes the Magnificent Four or the Fabulous Four or whatever is left, then small-caps are going to benefit from the broadening of the overall market and the fact that they are just so cheap, said Francis Gannon, co-chief investment officer at Royce Investment Partners.

Gannon said the explosion in small-cap shares in the fourth quarter portends well for the group in 2024, as well as for the market in general. When the equal-weighted Russell 1000 outperforms as it did the final three months of last year, small-caps typically outperform the S&P 500 by 600 basis points, he said.

Earnings will be the big story for small-caps this year, Gannon added, not just valuation and the end of Federal Reserve rate hikes.

Small-cap earnings “have been trailing the large-cap space and will start