Small-cap stocks were broadly expected to benefit from deregulation and lower taxes under the Trump administration.
Both regulation and taxes tend to weigh more on the bottom-lines of smaller companies than they do on their larger counterparts. Still, small-cap stocks haven’t been able to do all that well in recent months.
However, things sure could change moving forward. According to Wolfe Research strategist Rob Ginsberg, the US small-cap stocks are strongly positioned for a significant rally ahead.
Why haven’t the small-cap stocks done well?
Investors have been wary of investing heavily in the US small-cap stocks primarily because it’s been ages since they succeeded in outperforming the large-cap names.
In fact, large-cap stocks have done significantly better than the small-cap stocks index in nine of the past 11 years. Last year, for example, the Russell 2000 returned just 10% versus well over 20% for the S&P 500.
Nonetheless, there’s reason to believe that this Trump trade has been getting ready for a meaningful run to the upside that may materialize over the next quarter or so, according to Ginsberg.
What signals a big move to the upside in small-cap stocks?
It hasn’t been all that long when small-cap stocks were struggling to pull out of the read.
At writing, however, the Russell 2000 has all of its sectors in the green over the past month, and now “further gains looking likely,” as per the Wolfe Research strategist.
“The index has carved out a compelling multiyear base after several years of choppy, range bound trading and struggles,” he added in a research note last week.
The small-cap index currently sits a little below a key resistance at the 2,450 level. A breakout could clear the path for “a massive run” in the group, Ginsberg argued in his report.
What interest rate cuts could mean for the Russell 2000
President Trump is broadly expected to favour policies that could lift the US economy in 2025. Some experts even see the GDP improving by as much as 5.0% this year.
That could also prove to be meaningful for small-cap companies as they drive a bigger chunk (up to 80%) of their revenue from the domestic market.
Finally, small-cap stocks are worth buying as the Fed is expected to cut interest rates further in 2025.
Why? Because smaller companies often have higher levels of debt. A decline in borrowing costs, therefore, helps free up their capital for growth.
Small-cap firms also rely more on external financing, the cost of obtaining which reduced when interest rates are cut.
All in all, these companies are more nimble and have more room for rapid growth compared to their larger counterparts.
Lower borrowing costs allow them to capitalise on growth opportunities more easily.
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