So far this year, it seems like Wall Street’s focus has been on two things: 1) the artificial intelligence trade and 2) the Federal Reserve’s fight to tame inflation and the hope of key interest rate cuts.
Meanwhile, there is a group of stocks that’s been flying under Wall Street’s radar: small caps.
After lagging their large-cap peers for the better part of the year, small-cap stocks made big moves in the third quarter…
- The small-cap Russell 2000 soared 9% in the third quarter.
- The small-cap index hit an all-time high of 2,300 in late July.
- And the Russell 2000 climbed nearly 2% in September.
So, in today’s Market 360, I’ll share what’s behind the strength in small caps, and how this could be just the beginning of a much bigger rally. But before we dive in, let’s first review what a small-cap stock is…
What Is a Small-Cap Stock?
Small-cap companies can be some of the most innovative and profitable on the market. Though they are sometimes misinterpreted as only startups or brand-new companies, they are technically just companies whose total market value, or market capitalization, ranges from about $300 million to $2 billion. Large-cap stocks, in comparison, have a market value of $10 billion or higher.
The appeal of small-cap stocks is that, because they are small and often trade at lower prices, there is greater potential for big gains in a short period of time. There is also hope that a small-cap stock could become the next Apple Inc. (AAPL) or Amazon.com, Inc. (AMZN).
But the reality is that with greater growth comes greater risk and volatility, and small-cap stocks can often lack stability. For example, the Russell 2000, the small-cap index, fell 22.3% in 2022. Compare that to the S&P 500’s 19.7% decline and the Dow’s 9.2% fall. If you pick the wrong small-cap stock, you could end up with a real dud on your hands and do serious damage to your portfolio.
On the flip side, if you pick the right small-cap stock, you could find yourself with a big winner on your hands. And right now, with the small-cap Russell 2000 benefiting from a major event, it is a great time to invest in these companies. So, what is driving small-cap stocks right now?
Small-Cap Stocks Love Lower Interest Rates
One of the driving forces behind the small-caps surge was the cut in key interest rates. Simply put, smaller-cap companies tend to have bigger debt loads than larger companies, so they benefit immensely from lower rates.
Now, because small caps are more sensitive to rates and the economy than large caps, they should be some of the biggest beneficiaries as rates continue to come down and visibility to a soft landing improves. My InvestorPlace colleague Luke Lango notes that this is especially true considering the huge valuation discount in small caps right now, with the S&P 500 Small-Cap Index trading at 19 times forward earnings and the S&P 500 Large-Cap Index trading at 24 times forward earnings.
He also points out that we could be on the verge of a technical breakout with small caps…
The S&P 500 has meaningfully outperformed the Russell 2000 since early 2021. And as such, we’ve seen a substantial downtrend in performance ratio of the S&P 500/Russell 2000. But, if you look at the chart below, you’ll see that it is currently breaking above its 2021 downtrend resistance line for the first time since early 2021. And that could signal that small caps may finally be ready to break out.
The bottom line: Luke and I both think small caps are poised to outperform over the next 12 months, continuing the broadening of this rally. And Luke has found one way to pounce on this…
In short, Luke has found a sub-$3 stock that could play a key role in Elon Musk’s new AI product that will be revealed on October 10.
That’s when Musk is expected to unveil his highly anticipated “Robotaxi.” And if it’s like any of Elon’s other innovations, it could be an absolutely groundbreaking achievement.
But instead of buying shares of Tesla, Luke is recommending a small sub-$3 stock that will play a key role in the Robotaxi’s development. And if he’s right, it could make an absolute killing for investors who get in early.
Which is why on Monday, October 7, at 10a.m. Eastern time, Luke is hosting a special strategy session to give you all the details on this little-known supplier.
Go here for more details and save your seat for the event now.
Sincerely,
Louis Navellier
Editor, Market 360
