Small caps have been all the rage on Wall Street over the past two months.
In fact, according to Bank of America’s latest fund managers survey, investors haven’t been this bullish on small caps in almost three years.
The survey conducted from Jan. 5-11 revealed investors see large-cap companies underperforming small-cap companies in the next 12 months for the first time since June 2021.
Small caps have ripped higher amid the soft-landing-fueled rally, which has seen investors price in roughly six interest rate cuts in 2024 as inflation has fallen faster than many predicted. From late October to mid-December, it took just 48 days for the Russell 2000 to rise from a 52-week low to a new 52-week high, marking the fastest turnaround for the index ever, per Bespoke Investment Group.
Now, with the index up over 16% since its October lows, the key question for investors is whether the index has already priced in the future benefits of lower interest rates, limiting the upside in buying small caps.
Goldman Sachs says no.
“The combination of low current valuations and a healthy economic outlook implies that the Russell 2000 should return roughly 15% in the next 12 months,” the Goldman Sachs equity strategy team led by David Kostin wrote in a note to clients on Jan. 12.
A key caveat to this call could be if “investor expectations for economic growth deteriorate.”
Lori Calvasina at RBC Capital Markets has been recommending small-cap stocks for months. Much of Calvasina’s case for why small caps could out perform remains intact. That is: Small-cap stocks have outperformed in prior interest rate cutting periods — and their exposure to higher interest rates wasn’t as bad as feared. But a key part of Calvasina’s call, that small caps had been oversold, has flipped amid the recent market rally.
This has Calvasina “concerned” about how popular the call for small-cap stocks to gain has become.
“In December it felt like everyone we met with (including the many varieties of investors who are not focused on Small Cap investing) wanted to talk about Small Caps and was constructive on them,” Calvasina wrote in a note on Jan. 8.
She added: “We can’t remember the last time this happened.”