Small-сap stocks could rise 15% in August – Fundstrat research head

Fundstrat Global Advisors believes that small-cap stocks could rise 15% in August. The Russell 2000 index finished 1.3% higher on Thursday, July 25, and is now up 11% over the last three months and up 8.5% over the last month. JPMorgan expects returns on small- and mid-cap stocks to be sustainable over a time horizon of 10-15 years.

Details

The rotation into small caps is just beginning, and small-cap share prices could rise 15% in August, Tom Lee, a managing partner and the head of research at Fundstrat Global Advisors, suggested in an interview with CNBC.

Small caps continue to rise as investors move out of tech giants, notes Reuters. The Russell 2000 index, made up of 2,000 small-cap stocks, rose 1.3% on Thursday, partially paring Wednesday’s losses. The S&P SmallCap 600 also advanced, gaining 1.4% for the day. Meanwhile, the S&P 500 and Nasdaq Composite indexes fell 0.51% and 0.93%, respectively.

While large-cap stocks have driven the market’s climb to historical highs this year, Wednesday’s selloff – following disappointing earnings from Tesla and Alphabet – ramped up fears that large caps might be overvalued and face further headwinds, Reuters reports. This has pushed investors toward smaller-cap stocks and other sectors outside of Big Tech.

What other analysts are saying

In the U.S., returns on small caps should be sustainable over 10-15 years, meaning they can provide long-term benefits to investors, according to JPMorgan analysts. In addition, they represent an opportunity for diversification. JPMorgan recommends allocating 5-10% of a portfolio to small caps.

However, investors are warned to be selective –  some companies are deep in debt or not profitable, which is an important consideration given the high interest rates.

Even before the July rotation got underway, JPMorgan had suggested that there was not a better entry point for small-cap stocks than now. Small companies are generating similar cash flows and margins relative to comparable large companies but their shares are cheaper – a gap that will close over time, the analysts expect.

Even though over the past decade small- and mid-cap stocks have lagged behind large caps, their earnings have grown faster. This is because many small companies are innovative and dominate their markets, JPMorgan believes.

“If you hear about a stock that doubled in a week… chances are it’s a small cap. For every big winner, there are plenty of losers,” wrote Simply Wall St in a report titled “Opportunities and Risks in the Small Cap Universe.”

The small-cap universe is full of companies with great ideas, but turning them into profitable businesses is not easy, cautions Simply Wall St. IPOs, they add, are expensive and time- and effort-intensive, and sometimes being public means that a company was rejected in the private market.

Context

“I would buy small-cap stocks if I started investing now with a million dollars or less,” said Warren Buffett, the head and largest shareholder of Berkshire Hathaway, back in May.

That same month, it emerged that billionaire Stanley Druckenmiller‘s family office, Duquesne, had bought $664 million worth of call options on the Russell 2000. As of the end of the first quarter of 2024, call options on the Russell 2000 represented Duquesne’s largest position (15.1% of the portfolio, according to TheStreet.com), followed by investments in Microsoft (worth $468 million) and the South Korean online retailer Coupang (around $400 million), notes Business Insider.