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Investing in small-cap stocks is not for the weak-hearted. While quality small-cap stocks offer you the opportunity to derive exponential gains, only a handful of these companies will outpace the broader markets over time.
Typically, companies trading between the market caps of $300 million and $2 billion are defined as “small-cap stocks.” These companies may deliver outsized returns, but are often more volatile than blue-chip companies or other asset classes, such as bonds or gold.
Due to the higher risk profile of small caps, these companies should ideally deliver higher returns when compared with their larger counterparts. But in the last 10 years, the benchmark Russell 2000 Index (RUT) of small-cap stocks has returned just 74% - much lower than the S&P 500 Index's ($SPX) returns of 174%.
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If we expand the investment timeline further, the Russell 2000 has returned 239% since January 2004. In this same period, the S&P 500 has surged close to 332%.
Can Small-Cap Stocks Rebound in 2024?
The Russell 2000 is trading 20% below its all-time highs, as the stock market rally in 2023 was primarily driven by large-cap tech giants - such as Microsoft (MSFT), Apple (AAPL), Nvidia (NVDA), and Meta (META).
Interest rate hikes since the start of 2022 have made investors extremely nervous, as they expected the U.S. economy to enter a recession. However, a resilient economy and strong consumer spending allowed the S&P 500 to stage a remarkable comeback in the last 12 months, rising 20%. Comparatively, the Russell 2000 is up a paltry 3.4% since January 2023.
While small-cap stocks have trailed the S&P 500 by a wide margin, they remain a compelling investment at current levels - particularly since historical returns shouldn’t matter much to future investors.
And according to a report from Marketwatch, Tom Lee, the head of research at Fundstrat Global Advisors, is bullish on small-cap stocks this year. Lee expects the Russell 2000 to rise as high as 3,000 this year - a whopping 51% gain - while the S&P 500 might rise by “just” 7%. Previously, Lee garnered headlines late in 2023 for nailing the SPX price action last year, which many other analysts had underestimated.
With multiple interest rate hikes forecast this year amid cooling inflation levels and better-than-expected economic data, the time is ripe for small-caps to take off. Lee emphasized that the Russell 2000 is discounted by 44% compared to the S&P 500, if we consider the price-to-book ratio. Further, the small-cap index was at a similar level back in 1999, after which it outpaced the S&P 500 for more than a decade.
If the Federal Reserve cuts interest rates rapidly in 2024, investor funds are bound to shift from fixed-income securities, such as bonds, to higher-risk asset classes, including small caps.
How Can You Invest In Small Caps?
We can see that small caps might be positioned to beat large caps in 2024 for the first time since 2016. But how can you gain exposure to these stocks? Well, you can consider investing in the iShares Russell 2000 ETF (IWM), which tracks the RUT index.
With an expense ratio of 0.19%, the IWM exchange-traded fund has roughly $62 billion in assets under management and is among the most popular exchange-traded funds for small caps in the U.S.
On the date of publication, Aditya Raghunath did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.