Warren Buffett once said, “The most important item over time in valuation is obviously interest rates. If interest rates are destined to be at low levels, it makes any stream of earnings from investments worth more money.”
With those words of wisdom, there are perhaps no greater beneficiaries to an environment where the Fed is lowering interest rates (and potentially keeps them lower) than small cap stocks.
In fact, if we look at the above chart of the Russell 2000 vs the S&P 500 over the past 52 weeks (as of this writing), gains in small cap stocks have been roughly on par with the largest 500 listed companies, returning about 30% each.
Now, these on-par gains of the Russel 2000 are particularly noteworthy as the S&P 500 includes the heavily weighted, and market outperforming Magnificent 7.
As a group, these seven stocks (MSFT, AMZN, META, AAPL, GOOG, NVDA & TSLA) have returned nearly 60% YTD. And, over the past two years, these highfliers have returned nearly 150%… wildly outperforming the index.
They’re called the Magnificent 7 for a reason, after all.
A quick side note: The other 493 companies in the S&P 500 have returned about 35% during this two-year timeframe.
So, why has the Russell 2000 done so comparatively well in 2024? Especially after having such a dismal 2023 (returning a negative 1%)?
Well, as you know, the Fed not only began lowering interest rates, but the market itself began anticipating a continuation of the rate cut cycle. Simply put, in this rate lower environment, small cap stocks are having a field day… And it’s a field day that could last a few years…
Regardless of whether the Fed continues to cut in 2025 or not.
But you don’t have to take our word for it.
On December 2, Wharton professor and economist Jeremy Siegel told Business Insider, “I’m expecting a much quieter year. I mean, we’ve had two blockbuster years, 2023, 2024, so I’m expecting an S&P probably in the zero to 10% range…
“Maybe for once, we will see relative softness on the big highflyers that have been so good for the market the last two years… if they do falter next year or even really don’t increase, it’ll be hard for the S&P to make anything like the gains that we had in 2023 and 2024.
“Maybe the Mag 7 will do nothing next year, and those small and mid-sized cap stocks, which are really so undervalued compared to the others, are finally going to have their day in the sun.”
And that potential day in the sun may not only be found in the Russell 2000, but in individual small and mid-cap stocks as well… the ones “which are really so undervalued compared to the others,” as Mr. Siegel says.
But it’s not just a highly regarded Wharton economist who thinks small cap stocks could be in for a wonderful 2025.
On December 3, MarketWatch said, “While the statistics are favorable for small caps moving forward, so are the fundamentals. The U.S. economy continues to hum along, the Fed is on its path to lower interest rates, and earnings growth remains strong. Even the recent spike in 10-year Treasury yields has done little to deter small-cap investors.”
Now, we’re not saying the S&P 500 will be a lower returning index than the Russell 2000 in 2025 as Mr. Siegel seems to suggest…
Only time will tell.
And we’re not saying you should ixnay the SPX, dump Mag 7 shares and go all in on small caps, as MarketWatch seems to suggest may already be happening…
But should history (and the Fed) be any indication, 2025 could be a very good year in the small cap space.
So, you should certainly be paying very close attention to the Russell 2000, to individual small cap stocks, and you should be getting yourself prepared for what may turn out to be the best year for small cap stocks… this decade.