Small-Cap Stocks Set to Outperform with Rate Cuts Ahead

Small-Cap Stocks Gaining Momentum: Fundstrat's Tom Lee predicts a 100% outperformance for small-cap stocks over the S&P 500, driven by lower valuations and interest rate cuts, indicating potential positive shifts in stock prices.

Date: 05-02-2025

AI Rating: 7

Earnings and Performance Insight: The report highlights the potential for small-cap stocks to outperform large-cap stocks, particularly the S&P 500, due to favorable conditions such as interest rate cuts. This has implications for earnings expectations and overall stock performance.

Historical Context: The historical performance of the Russell 2000 shows an average return of 45% following the last five rate-cut cycles, suggesting that small-cap stocks may be well-positioned for a significant rebound. In contrast, the S&P 500 averaged a 33% gain in the same timeframe, indicating strong relative performance for small-cap stocks in similar future conditions.

Interest Rate Cuts: The initiation of interest rate cuts by the Federal Reserve creates an environment that benefits small-cap companies with a greater degree of floating-rate debt. These companies are expected to experience enhanced margins and overall profitability as borrowing costs decrease.

Limited Exposure to International Markets: The report points out that small-cap companies generally have less revenue exposure to international markets compared to large-cap firms in the S&P 500. This may provide an advantage amidst fluctuating U.S. tariffs and exchange rates, which can hinder larger companies reliant on overseas revenue.

Potential Risks: Despite the optimism surrounding small-cap stocks, the report suggests caution. Past performance does not guarantee future results, and there are concerns about whether these stocks can indeed double their performance relative to the S&P 500. Investors are advised to maintain modest positions in the Vanguard Russell 2000 ETF to mitigate risk.

Stocks: VTWO