An Impressive Surge for Small-Cap Stocks

Traders in the stock market may have experienced some volatility when it comes to small-cap stocks, but amidst the ups and downs, this particular section of the market has recently witnessed a remarkable surge.

Over the course of 50 trading days following the lows reached on October 27th, the Russell 2000 (RUT) index has surged by more than 20%. This marks the strongest 50-day rally since 2020 and is only one of 21 similar periods since 1979, as pointed out by analysts at Bespoke Investment Group.

It's worth noting that prior to the major market movements driven by the early stages of the COVID pandemic in 2020, there was one rally of comparable magnitude in March 2019. For an earlier instance, we have to go back to 2012 to find a similar experience, as highlighted by the analysts.

In the year 2023, the benchmark Russell 2000 spent a significant portion of its time in negative territory, while its large-cap counterparts, especially mega-cap tech stocks, soared. However, November brought about a change.

Small-cap stocks made a strong comeback, with the Russell 2000 surging by nearly 22% during the last two months of the year. As a result, it achieved a gain of 15.1% for the year 2023. This helped to narrow the gap with large-cap stocks, although the index still underperformed compared to the S&P 500's 24.2% gain and the Nasdaq Composite's impressive 43.4% rally. Nevertheless, it did manage to surpass the Dow Jones Industrial Average's gain of 13.7%.

As for what comes next, only time will provide the answer. However, based on historical records, there is reason for optimism.

Capturing the Market Upside: The Potential of U.S. Small-Cap Stocks

In recent weeks, the Russell 2000 index experienced a remarkable surge, crossing the threshold of a 20%-plus rally within a 50-trading day period. According to Bespoke, a renowned market analysis firm, historical data demonstrates that following such surges, the index tends to outperform its long-term average returns (see chart below). This trend holds true regardless of whether one examines the short-term (one week) or long-term (one year). While past performance does not guarantee future results, this knowledge could certainly prove valuable for investors.

However, it is important to note that the standout performance of the Russell 2000 was slightly dampened by a recent pullback at the start of the new year. Both the Russell 2000 and the S&P 600 SML, another small-cap benchmark, experienced declines of over 3%, whereas the S&P 500 only saw a slight dip.

Despite this temporary setback, UBS Global Wealth Management provides compelling reasons to consider adding small-cap exposure to investment portfolios. In a note released on Wednesday, Solita Marcelli, Chief Investment Officer for the Americas at UBS Global Wealth Management, emphasized the potential for significant earnings growth in the S&P 600 small-cap index.

Marcelli pointed out that UBS's projection of a 9% earnings growth for the S&P 500 in 2024 indicates a low-double digit earnings growth for the S&P 600 small-cap index during the same period. This marks a substantial improvement compared to the approximately 10% decline in S&P 600 profits seen in 2023. With this optimistic outlook for small-cap stocks, UBS recommends that investors complement their core quality stock holdings with tactical exposure to U.S. small-caps in order to capture further market upside in the event of a continued equity market rally.

In conclusion, while recent market fluctuations and pullbacks should not be overlooked, the potential presented by U.S. small-cap stocks cannot be ignored. With historical data supporting their strong performance following substantial surges, investors have an opportunity to enhance their portfolios and benefit from the promising growth outlook for small-cap companies in the years ahead.