Small-cap stocks may be poised for a big rally in the next 6-12 months, according to Sean Gallagher, who oversees investments in the asset class at Lazard. He estimates that the Russell 2000 index could gain as much as 30-50% amid Fed rate cuts.
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Sean Gallagher, the global head of the small-cap equity platform at Lazard, which manages $205 billion in assets, believes that small-cap stocks, as represented by the iShares Russell 2000 ETF, could surge 30-50% in the next year. Small caps have been significantly lagging their large-cap peers for an extended period, a key factor supporting Gallagher’s view, which he laid out in an interview with Benzinga. In 2024, the publication notes, small-cap stocks have underperformed the large-cap S&P 500 by 10 percentage points, 30% over the past three years, and almost 50% over the past five years.
Factors supporting a small-cap rally
— Expected Fed rate cuts: Gallagher expects the Fed to cut interest rates as inflation nears the 2% target. According to a recent Reuters poll, most economists expect a 25 basis point cut at each of the three remaining FOMC meetings in 2024. Lazard sees up to 200 basis points of rate cuts over the next year, which Gallagher believes could provide a significant boost to small-cap stocks, since smaller firms are more leveraged and sensitive to borrowing costs than large firms. He predicts that the sectors that will benefit the most from a lower interest rate environment are financials, health care, and consumer durables.
— Valuation gap: Small caps have a median P/E ratio (the lower it is, the better for investors) of 9.5, which is “incredibly attractive” relative to large caps, argues Gallagher. “Small caps look exceptionally cheap,” he sums up.
— Trump win better for smaller companies: Historically, small-cap stocks have performed better under Republicans (whose candidate is Donald Trump in the November presidential election), as the party generally supports lower taxes and pro-market policies. Analysts at Goldman Sachs, meanwhile, predict stronger GDP and job growth if the Democrats, led by presidential nominee Kamala Harris, sweep the White House and Congress, Benzinga notes.
However, as Gallagher points out, there are risks that could derail a small-cap rally, the main one being that the Fed falls behind the curve in addressing a weakening economy. He stresses that signs of an economic slowdown are already evident, and though it’s hard to call it a recession yet, the Fed needs to act quickly to avoid one.
