Why I'm Expecting Small Caps to Outperform This Quarter
The Russell 2000 should play "catch up" in the last stanza of 2024.
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It has been an auspicious start to the final quarter of 2024, to say the least.
Israel has launched at least a small ground incursion into Lebanon. Ballistic missiles have been fired by Iran onto Israel, taking Middle East tensions in a dangerous new direction. The first full-scale port strike by longshoremen since 1977 has gotten underway and the Carolinas are struggling to recover from the devastation wrought from Hurricane Helene.
It is not surprising, then, that the first day of the fourth quarter was a down one for investors on Tuesday. In fact, given the news, the just over 1.5% drop in the NASDAQ was not alarming, especially as the S&P fell just less than 1%.
In addition, the first weeks of both August and September saw sharp falls in equities, only for the indexes to be at all-time highs by the end of the months. Will recent history repeat? As my late father, liked to quip, "Only the shadow knows." However, one thing I am expecting to happen in the fourth quarter is that small caps should outperform their larger brethren. There are several reasons for that belief.
First, the small-cap Russell 2000 had returns of approximately half that of either the S&P 500 or NASDAQ in the first three quarters of 2024. The fourth quarter should see some "catch up" trading action and small caps should benefit to a greater extent from the end of tax-loss selling. In addition, large caps tend to hold more cash, have better credit ratings and have more financial flexibility than most small-cap names. The recent cut in the federal funds rate should favor the fortunes of the names in the Russell 2000 more than large-cap names like Microsoft MSFT that have cash hoards that were raking in interest revenues.
The same action happened last year, when the Russell 2000 gained 14% while the S&P 500 "only" returned 9% or so. We started the third quarter at all-time highs and, with the S&P 500 trading at over 25 times trailing earnings and roughly three-times revenues, the latter being right at the all-time highest level the S&P has ever posted.
Therefore, I don’t expect the same type of gains from either index to close out this year. However, the odds do seem good the Russell 2000 should be an out-performer in the final quarter of 2024.
In my column on Friday, I will highlight several small-cap names that look poised to do well to close out the trading year.
At the time of publication, Jensen had no positions in any securities mentioned.
