US small-caps rising

The investment landscape for small-cap stocks has shown a notable recovery in the third quarter of 2024, with the Russell 2000 Index outperforming both large-cap and mega-cap indices. This rebound, however, was concentrated in a strong July performance, followed by more modest returns in August and September. Despite this recovery, small-caps still lag behind large-caps in year-to-date performance, indicating a challenging path to market leadership.

The Federal Reserve's mid-September interest rate cut, along with a potential for further cuts, has created a more favorable environment for small-caps. Historically, small-caps have performed well following rate reductions, suggesting potential for continued gains. Additionally, small-cap value stocks have shown strength, particularly in the financial sector, which could benefit from a growing economy and stable interest rates.

Sector-wise, financials, healthcare, and industrials were significant contributors to small-cap performance, with banks and biotechnology leading the way. The relative valuation of small-caps compared to large-caps remains attractive, with the Russell 2000's price-to-earnings ratio below its long-term average, indicating potential undervaluation.

Looking forward, small-caps benefit from an estimated earnings growth advantage over large-caps for the remainder of 2024 and into 2025. This, combined with their historical performance patterns following periods of low returns, paints a positive outlook. Financial advisors and portfolio managers should consider these factors when evaluating small-cap investments, as the current economic conditions and valuation metrics suggest potential opportunities for growth and market leadership in the coming months.