Small-cap stocks are starting to show signs of life lately. The iShares Russell 2000 ETF (IWM) climbed 2.4% over the past week, outpacing the S & P 500’s 1.9% rise during the same period, suggesting the asset class could start to finally break out after its lackluster performance this year. While the IWM has delivered 12% this year, that is far below the S & P 500 gain of almost 23%. The latest move has investors wondering whether now is the time to put money into small caps, as the asset class is more attractively valued when compared to large-cap peers. What’s more, September’s big half-point rate cut from the Federal Reserve is expected to be especially beneficial to smaller companies that often have more leverage on their balance sheets. “Historical data suggest that smaller-cap stocks have tended to be main beneficiaries once the Fed begins to lower rates,” BMO Capital Markets’ Brian Belski wrote earlier this month. “Therefore, we continue to advise investors to increase exposure to this area since we believe it is only a matter of time before the fortunes of this group take a turn for the better.” IWM YTD mountain IWM Many investors are uncertain how long the latest trend can continue. The Russell 2000 ETF is higher by 1.6% in October against 1.2% for the S & P 500, but over the past three months, the S & P 500 has outperformed, 3.6% to 3.3%. Even if small caps appear to have a more attractive setup at a time when interest rates are poised to ease, plenty of market observers underscore the fundamental strength in megacaps as a reason to stick with the technology leaders. “We think Fed rate cuts have a strong ability to create a favorable backdrop for small-cap stocks,” Michael Graham, analyst at Canaccord Genuity, wrote Tuesday. “However, investors should keep in mind that Mag7 strength has appeared largely rational, and continued ability to grow at healthy rates should at a minimum dampen the magnitude of any such rotation,” Graham added.
