Statistical data shows that the Russell 2000 index has risen 7.3% so far in August, leading the gains in the entire U.S. stock market. This represents its best performance relative to the large-cap benchmark—the S&P 500 index—since July 2024. As the Federal Reserve appears poised to announce an interest rate cut at next month's FOMC monetary policy meeting, there is ample reason and logic to predict that the index will achieve even larger gains. Key beneficiaries expected to gain from easier monetary policy include regional small and mid-sized banks and small technology and industrial companies, which hold significant weight in the Russell 2000 index.
"The potential for this small-cap index to continue rising clearly exists, and it could be much stronger than large caps going forward," said Matt Maley, Chief Market Strategist at Miller Tabak+Co. "You now have stronger upward momentum, which has been sorely missing for a long time."
Long Streak Without New Highs – The duration without small-cap stocks reaching new highs is on track to be the longest since the dot-com bubble burst.
Maley stated that another very crucial bullish signal comes from the iShares Russell 2000 ETF (Ticker: IWM), which is trading above $230, breaking through a critical technical level. Nevertheless, he cautioned investors to be wary of excessive market euphoria.
Maley's bullish stance on small-cap stocks is not an isolated view in the market. RBC Capital Markets also favors small-cap stocks outperforming the S&P 500 and the tech-heavy Nasdaq 100 index, based on the macro expectation of the Fed restarting its rate-cutting cycle.
The current landscape of the U.S. capital market shows a pattern of "large caps overvalued, small companies undervalued": a few tech giants have lofty valuations while most stocks are still not overheated. Coupled with improvements in the macroeconomic environment and expectations for a turning point towards looser monetary policy, investors are beginning to prepare for a potential style rotation—moving away from the hot but historically high-valued tech giants towards buying the dip in long-neglected quality small and mid-cap stocks with solid fundamentals.
Looking across the entire U.S. stock market, the seven tech giants have been the strongest engine leading the market's gains since 2023. Their powerful market positions in AI driving exceptionally strong revenue, rock-solid fundamentals, consistently strong free cash flow reserves over the years, and expanding stock buyback scales have attracted a flood of global capital. However, the historically high valuations of the "Magnificent Seven" are making Wall Street increasingly cautious—six of the seven tech giants have forward P/E ratios far above the 25x valuation of the S&P 500 index, whose valuation is also near its own historical highs.
However, RBC also emphasized the need to focus not only on Fed rate cut expectations but also on the economy's fundamentals. "We still don't believe that Fed rate cuts alone will bring about a sustained period of small-cap outperformance over large caps or the tech giants, unless the economic backdrop is stronger than it is currently or than most economists are predicting," wrote Lori Calvasina, Head of U.S. Equity Strategy at RBC Capital Markets, in a report to clients on August 24th.
