As we move toward the end of 2024, small-cap stocks continue to present a compelling opportunity for investors seeking growth and diversification. Amidst market shifts, interest rate cuts, and broader economic changes, small-cap stocks are well-positioned for potential outperformance in the coming months. Here’s why small caps are primed to be one of the best investment opportunities for the remainder of 2024.
The Power of the “Great Rotation”
This year, the “Great Rotation” from large-cap to small-cap stocks has gained momentum. We’ve written extensively about this trend in the past. For several years, large-cap stocks, especially in the technology sector, dominated the market and drove the majority of gains, often leaving small-cap stocks overlooked and undervalued. However, recent interest rate cuts by the Federal Reserve have reignited interest in smaller companies, especially in sectors such as real estate, regional banks, and industrials, which tend to benefit directly from lower borrowing costs. See more on the historical track record of Small Cap outperformance in declining rate environments here.
Small-cap companies are particularly sensitive to interest rate changes, as they typically rely more heavily on borrowing to fuel growth compared to large-cap firms. With the Fed expected to continue rate reductions as inflation eases, small-cap stocks are positioned to take advantage of these favorable financial conditions. This shift makes small caps an attractive play for investors looking to capitalize on growth-oriented sectors and companies.
Attractive Valuations Compared to Large Caps
Valuations for large-cap stocks, especially in the S&P 500, have reached historical highs, with price-to-earnings (P/E) ratios pushing above 25x, compared to the long-term average of around 18x. In contrast, small-cap stocks, particularly those in the Russell 2000 index, are trading at multiples near their historical averages, potentially offering a more appealing entry point.
Historically, small caps have tended to outperform larger stocks following periods of economic recovery. As the U.S. economy stabilizes and inflation moderates, investors are increasingly drawn to small caps’ growth potential at lower valuations. Given that small caps are trading at more favorable multiples while still delivering strong earnings, they offer a compelling opportunity for growth with less valuation risk than their large-cap counterparts.
High Earnings Growth Potential
One of the most compelling aspects of small-cap stocks is their capacity for outsized growth. Large-cap companies may offer stability, but their sheer size limits their potential for rapid expansion. Small-cap companies, on the other hand, are often in the earlier stages of their growth journeys, giving them room to scale quickly and capture market share in expanding industries.
With many small caps operating in niche sectors or specialized industries, they can pivot more quickly, innovate, and respond to market demands without the bureaucratic inertia that can encumber larger companies. For example, technology and healthcare small caps are well-positioned to benefit from advances in artificial intelligence, biotechnology, and cybersecurity, areas where rapid adoption can lead to substantial revenue gains.
Additionally, small cap earnings are projected to grow at a faster pace than their large-cap counterparts. Earnings for the S&P 500 are projected to increase by 10% in 2024 and 13% in 2025, while estimated earnings for the Russell 2000 are expected to increase by 36% into 2025. For investors seeking value, looking beyond traditional large cap sectors may present interesting opportunities. At Ironwood, our research efforts are increasingly focused on identifying these underappreciated companies that have been passed over in the recent market rally.
Market Inefficiencies and Investment Opportunity
Another reason small-cap stocks are poised for strong performance in late 2024 is that they are less covered by major Wall Street analysts, creating inefficiencies in their pricing. This lack of coverage allows diligent investors to uncover high-quality small-cap companies that are underpriced relative to their true value. For actively managed strategies, this offers an advantage, as small-cap stocks can deliver returns based on fundamentals rather than speculative trends, making them ideal for value-oriented investors.
A Resilient U.S. Economy Supports Small Caps
The U.S. economy has shown resilience, continuing to grow despite recent challenges. This steady economic backdrop benefits small caps, which often derive the majority of their revenue domestically. With an outlook for steady growth and improving economic conditions, small-cap stocks are well-positioned to benefit from an expanding U.S. economy.
As inflation stabilizes, consumer confidence improves, and borrowing costs decline, small-cap companies are set to thrive in sectors like consumer discretionary, industrials, and financials, which stand to benefit from increased domestic spending and investment.
Conclusion: Don’t Miss the Small-Cap Opportunity
The remainder of 2024 is shaping up to be a pivotal period for small-cap stocks. With favorable economic tailwinds, lower interest rates, attractive valuations, and unique growth potential, small-cap stocks offer a compelling opportunity for investors looking to diversify their portfolios and capture market inefficiencies. While large caps may provide stability, the agility and growth dynamics of small caps make them an ideal choice for those seeking higher returns.
As market attention shifts and the “Great Rotation” continues, small-cap stocks are positioned to shine. Don’t miss the opportunity to invest in these promising, undervalued companies as they gear up for potential outperformance.
Contact us today to learn more about Ironwood’s track record of performance and decades of leadership in the small cap sector
Seize the Opportunity in Small-Cap Investing Today
The remainder of 2024 presents a unique opportunity for investors to capitalize on the growth potential of small-cap stocks. With favorable economic trends, lower interest rates, and attractive valuations, small caps stand out as a powerful choice for portfolio diversification and growth. As the “Great Rotation” gains momentum, these agile companies are well-positioned to benefit from market shifts and an expanding U.S. economy.
Don’t miss the chance to invest in promising small-cap companies with the potential for outsized returns. Contact Ironwood Investment Management, LLC today to explore how our expertise in small-cap investing can help you navigate the evolving market landscape and achieve your financial objectives.
PERFORMANCE DATA AND DISCLOSURES
Performance Statistics as of 9/30/2024
Ironwood Investment Management®, LLC (Ironwood) is an independently managed investment advisory firm providing investment advisory services to institutional clients, mutual funds and high-net-worth clients. The firm is a registered investment adviser with the Securities and Exchange Commission. SEC Registration does not imply a certain level of skill or training. Accounts in the Small Cap Core composite include separately managed, fully discretionary, fee-paying portfolios. Portfolios are invested in undervalued securities, the majority of which will have market capitalizations under $2.5 billion at cost, including securities with growth and/or value characteristics. Securities are considered undervalued when management believes the current share price does not accurately reflect the long-term economic value of the underlying company. Ironwood Investment Management, LLC claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Ironwood Investment Management, LLC has been independently verified for the periods January 1, 1999 through December 31, 2021. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. The Small Cap Core composite has had a performance examination for the periods July 1, 2002 to December 31, 2021. The verification and performance examination reports are available upon request. GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. The creation date of the composite: July 2002. Performance inception date of the composite: January 1, 1999. Prior to July 2002, portfolios were included in the composite when at least 75% of the portfolio was invested in equity securities and when at least 75% of the portfolio was invested according to the investment style of the composite. Subsequent to July, 2002, portfolios are included in the composite after the first full month of being fully invested. Returns are presented gross and net of management fees and include the reinvestment of all income. Net returns are calculated based on the highest fee of 1.00%. Investment management fees are 1.00% on the first $25 million, 0.90% on the next $25 million, 0.80% on the next $50 million, and 0.75% over $100 million on an annual basis and a client’s return will be reduced by these and other related expenses. The actual fee charged to an individual portfolio may vary by size and type of portfolio and may be negotiated. Actual investment advisory fees incurred by clients may vary. The Russell 2000 Index consists of the 2000 smallest stocks in the Russell 3000 Index that represents approximately 8% of the U.S. equity market capitalization. The indices have been reconstituted annually since 1989. Ironwood returns and Index performance reflect reinvested interest income and dividends, in U.S. dollars. A list of composite descriptions and a list of limited distribution pooled fund descriptions are available upon request. Past performance is not indicative of future results. Policies for valuing investments, calculating performance and preparing GIPS Reports are available upon request. Prior to May 2006, the Firm was known as Ironwood Capital Management, LLC.