Year to date, the Russell 2000’s scant 1% gain is dwarfed by the S&P 500’s 18% gain. But that could be changing. After dominating much of 2023, large-caps could potentially step aside for small-caps to take the majority of gains.
When small-caps eventually rally over large-caps is anybody’s guess. Yet some analysts believe the time is now. As 2023 comes to a close, it could be small-caps outperforming large-caps.
“So I do believe that this is the start of the fourth quarter rally for small cap stocks,” said Eric Green, CIO of Penn Capital Management. “It’s been long overdue. Large cap stocks have massively outperformed for a long period of time. And valuations have just gotten very compressed relative to large cap companies.”
Technically, large caps, particularly in the big tech arena, could be in overbought territory. Fundamentally, large-cap valuations could be reaching exorbitant levels after 2023’s run higher, making small-caps an attractive option for value-oriented investors.
“Fundamentals are not that bad, and the data, the economic data that’s come in, the employment report as well as the CPI show that inflation is coming down, and that’s one of the ingredients that we need for small cap stocks to work here,” Green added.
With high inflation, the threat of a recession is also looming in the backdrop. However, Green thinks that small-caps are already priced for a recession versus large-caps.
“Small caps have are actually priced about the average for the amount down from their peak before a recession,” Green added further. “So small caps, if anything, are fully priced for a recession whether it happens or not, where large caps have not priced that in whatsoever.”
2 Options to Trade a Small-Cap Rally
If small-caps can push past their large-cap peers, then traders will want to look at the Direxion Daily Small Cap Bull 3X Shares (TNA). The fund offers 300% exposure to the aforementioned Russell 2000 index. That gives traders extra profit potential if their bullish notions are correct.
High inflation has been giving large-caps the advantage given their stability versus small-caps. As macroeconomic conditions change and inflation eases, small-caps could start to exhibit strength.
If investors subsequently head out of the safety of large-caps and into riskier assets like small-caps, then traders can play the inverse of the S&P 500. If bearishness occurs in the index, then traders can use the Direxion Daily S&P 500 Bear 3X ETF (SPXS).
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