Fundstrat’s Tom Lee expressed optimism regarding the small-cap-heavy Russell 2000, predicting a 15% or more jump in August. He explained to CNBC that investors are anticipating a September rate cut, which would provide borrowing flexibility, benefiting small-cap stocks. Expectations of a Trump White House are also driving small-cap buying, Lee added. With the tech sector experiencing declines, smaller stocks are gaining prominence this summer.
Historically, the Russell 2000 has shown strong performance under similar conditions. Lee highlighted that the index has already achieved over a 10% gain in July. He attributed the rally to market certainty about upcoming interest-rate cuts, expected to begin in September. These cuts are particularly advantageous for small-cap companies, which often have higher debt exposure and stand to benefit significantly from lower borrowing costs.
Conversely, persistently high interest rates have been a factor in the Russell 2000’s underperformance in recent years. Lee noted that smaller stocks are on the verge of breaking out of their longest drought since the financial crisis, having recently surged 10.5% in the last two weeks, approaching their all-time high.
Despite the recent rally, some strategists remain cautious. Jill Carey Hall from Bank of America expressed skepticism due to weak earnings. She emphasized the need for selectivity in investing, advising a focus on economically sensitive sectors like energy, industrials, and materials. Hall’s caution stems from the recent trends in earnings expectations, which have been falling, leading to concerns about the sustainability of the rally.
Lee acknowledged these concerns but remained confident, noting that the small-cap index has seen a gradual rise, rather than a sharp, unsustainable increase. He pointed out that the Russell 2000 has achieved a 1% gain over the past 10 of 11 days, a pattern historically associated with strong subsequent performance. Lee projects that the rally, which he initially expected to last around 10 weeks starting in August, could result in a 40% gain over time.
Aside from easing interest rates, Lee also cited the upcoming election outlooks as a factor boosting the Russell 2000. With betting markets indicating a Donald Trump presidency, investors are likely enticed by small-caps due to Trump’s policies favoring deregulation, mergers and acquisitions, and regional banks.
While some on Wall Street are skeptical about the rally’s durability given small-caps’ lackluster earnings and revenue, Lee’s optimistic view suggests that investors focused on free cash flow or price-to-earnings ratios may find small-caps more attractive, especially as enthusiasm for large-cap stocks, driven by the artificial intelligence narrative, begins to wane.