Small-cap stocks are poised for a strong performance in 2024, following a year of significant underperformance compared to the S&P 500, according to Fundstrat’s Tom Lee. In a recent CNBC interview, Lee said he believes that small-cap stocks could potentially surge by up to 60% this year, primarily due to their attractive valuations relative to the S&P 500.
“I believe that small caps have the potential to outperform large-cap stocks, possibly reaching gains of 50% or even 60%,” he said. “I anticipate that the Russell 2000 index could finish the year above 3,000.”
The Russell 2000 was trading at around 1,910 on January 17th.
In 2023, the Russell 2000 notably lagged behind the S&P 500, posting a gain of approximately 17% compared to the S&P 500’s 24% gain. This underperformance has carried over into 2024, with the Russell 2000 experiencing a year-to-date decline of approximately 7%, in contrast to the S&P 500’s 1% drop.
Despite these challenges, Lee emphasized that valuation metrics make the small-cap Russell 2000 index particularly compelling when compared to the S&P 500. He pointed out, “On a price-to-book basis, small caps relative to the S&P 500 have returned to levels last seen in 1999, which marked the absolute low and marked the beginning of 12 years of small-cap outperformance.”
Lee has declared small-cap stocks as his top investment idea for 2024, partly due to the belief that broader participation in the ongoing stock market rally is increasing, no longer solely concentrated in mega-cap tech stocks, as it was in 2023. If market breadth continues to improve, Lee expects that small-cap stocks will gain traction in 2024.
In addition to these factors, Lee identified three key drivers that could boost small-cap stocks in 2024:
- Fund Flows
Lee emphasized the importance of retail funds flowing into the stock market for small-cap stocks to outperform. A shift in investor sentiment toward the stock market could lead to increased interest in small-cap stocks in 2024.
- Interest Rates
Small-cap stocks are often highly leveraged and tend to have a higher cost of capital. Consequently, a decline in interest rates is expected to have a more significant positive impact on small-cap stocks compared to large-cap stocks.
- Economic Growth
Lee sees an expansion in economic growth as a substantial tailwind for small-cap stocks, given their significant exposure to the domestic economy.
He predicts that small-cap stocks are well-positioned for a strong performance in 2024, citing compelling valuations, improving market participation, and favorable economic conditions as key factors driving their potential.