The Wall Street story of 2023 was the meteoric rise of the mega-cap tech-heavy Nasdaq 100 Index QQQ, which soared by an impressive 50%. Fueled by stalwarts like Microsoft (MSFT) and Meta Platforms (META), the technology sector, especially Nvidia (NVDA) and Advanced Micro Devices (AMD), displayed remarkable resilience while hitting fresh 52-week highs. However, given the historical performance of best-performing equities, investors are now contemplating the potential of small-cap stocks in 2024.
Reversion to the Mean Potential
The Russell 200 Index broke its 500-day drought without making a 52-week high, the longest in its history – surpassing the Internet Bubble and the Global Financial Crisis. This significant underperformance sets the stage for a potential reversion to the mean trade, signaling the likelihood of the asset’s price returning to its historical average.
Image Source: SentimenTrader, Russell Investments
Strength Begets Strength
The Russell 2000 witnessed an impressive 21.9% gain in the two months leading up to 2023 – among its most robust two-month performances. Historical data reveals that when the Russell 2000 gained over 18.5%, it was consistently higher six months later, with an average gain of 19.2% – a strong indicator favoring the small-cap stocks.
Image Source: Ryan Detrick, Carson Research
Technical Set Up
The Russell 2000 Index ETF (IWM) is approaching an attractive reward-to-risk zone after three consecutive weeks of pulling back, making it a potentially lucrative technical move as it nears its 10-week moving average.
Image Source: TradingView
Dovish Fed Favors Small Caps
The CME Group’s FedWatch tool indicates market participants’ anticipation of six interest rate cuts in 2024. Lower interest rates are generally beneficial for small-cap stocks, as they reduce the cost of borrowing for businesses, particularly for small-cap companies that often depend on loans for operations and expansion. With lower interest rates, such companies can access capital at a more affordable rate, leading to improved profit margins due to reduced interest expenses.
Bottom Line
While mega-cap tech stocks shone in 2023, investors are advised to explore other market segments in 2024, especially small-cap stocks. With evidence mounting in favor of small caps, including reversion to the mean potential, momentum signals, and an appealing reward-to-risk technical zone, the outlook for small-cap stocks is increasingly bright.