Investing in small-cap stocks is not for the faint-hearted. While quality small-cap stocks offer the potential for exponential gains, only a handful of these companies can 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 to their larger counterparts. However, in the last 10 years, the benchmark Russell 2000 Index (RUT) of small-cap stocks has only exhibited a 74% return – significantly lower than the S&P 500 Index’s returns of 174%.
Broadening the investment timeline, the Russell 2000 has returned 239% since January 2004. In the same period, the S&P 500 surged close to 332%.
The Prospect of a Small-Cap Recovery in 2024
The Russell 2000 is currently trading 20% below its all-time highs, as the stock market rally in 2023 was predominantly driven by large-cap tech giants such as Microsoft (MSFT), Apple (AAPL), Nvidia (NVDA), and Meta (META).
Interest rate hikes since the beginning of 2022 have made investors extremely apprehensive, as they anticipated the U.S. economy to plunge into a recession. Nonetheless, a resilient economy and strong consumer spending enabled the S&P 500 to stage a remarkable comeback in the last 12 months, surging by 20%. In comparison, the Russell 2000 has only grown by 3.4% since January 2023.
While small-cap stocks have significantly trailed the S&P 500, they remain an appealing investment opportunity at current levels – particularly since historical returns are not indicative of future performance.
According to a report from Marketwatch, Tom Lee, the head of research at Fundstrat Global Advisors, is optimistic about small-cap stocks this year. Lee expects the Russell 2000 to rise as high as 3,000 in 2024 – a massive 51% gain – while the S&P 500 might rise by “only” 7%. Earlier in 2023, Lee accurately predicted the SPX price action which many other analysts had underestimated.
With multiple interest rate hikes projected this year amid easing inflation levels and better-than-expected economic data, the time is ripe for small-caps to soar. Lee emphasized that the Russell 2000 is discounted by 44% compared to the S&P 500, based on the price-to-book ratio. Furthermore, the small-cap index was at a similar level back in 1999, after which it outpaced the S&P 500 for over a decade.
Investing in Small Caps
Small caps may be poised to outperform large caps in 2024 for the first time since 2016. How can one gain exposure to these stocks? Well, one option is to 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 manages approximately $62 billion in assets and is among the most popular exchange-traded funds for small caps in the U.S.
