Futures suggest a positive start for equities, with the S&P 500 hovering near a record high.
Despite recent calm, analysts sense a significant shift in stock-market sentiment. Greg Boutle of BNP Paribas notes last Thursday’s softer-than-expected consumer price index report and subsequent dip in Treasury yields spurred a major rally in underowned and overlooked market segments. Small-cap stocks gained favor, while Big Tech saw heavy selling.
Though partially reversed on Friday, the question remains: Will small caps continue their upward trend?
Tom Lee of Fundstrat is optimistic. He sees small caps, tracked by the iShares Russell 2000 ETF (IWM), as having the “most compelling near-term investment case,” predicting a potential 50% gain in 2024. Currently up only 6%, there is significant room for growth. Lee attributes this to the low June CPI, which he believes signals continued small-cap rallies.
Lee’s optimism is based on five key points:
- Interest Rate Cuts: The probability of a 25-basis-point rate cut by the Federal Reserve in September is around 95%. Smaller companies, sensitive to borrowing costs, would benefit greatly from such a cut.
- Historical Performance: The IWM surged about 27% from October to December last year when the Fed paused rate hikes. Lee anticipates a larger, longer rally with an actual cut.
- Improving Sentiment Towards Regional Banks: Regional banks, heavily weighted in the IWM, are seeing improved sentiment, with the SPDR S&P Regional Banking ETF (KRE) breaking out to the upside.
- Lower Inflation Expectations: Lee argues that investor inflation expectations are too high and will lower, providing a boost for small caps.
- Narrowing Quality Spread: The narrowing yield spread between lower-rated small-cap debt and higher-rated large-cap debt indicates investor confidence in small caps, which typically leads to their outperformance.
“Suffice it to say, we see the conditions for a strong rally in IWM. And Mark Newton, head of technical strategy, believes a confirming ‘breakout’ of small caps could happen this week,” concludes Lee.
