The tickers might not be as exciting as the big tech behemoths dominating headlines, but small-cap stocks in the Russell 2000 (^RUT) index are starting to see real earnings growth after a year of strong performance.
Following several months of a rally driven primarily by growing P/E ratios — meaning higher multiples for investors — the Russell 2000’s 3% price return through September was entirely driven by upwardly revised earnings expectations, according to research published on Friday by Bank of America.
Analysts’ earnings forecasts for Russell 2000 names like theater and hotel operator Marcus Corporation (MCS) rose in September at the fastest pace since mid-2022, according to the report, as the small-cap index hit an all-time high near the end of the month. Those hopeful projections turned into concrete earnings growth.
At the end of the third quarter, small-cap stocks overall were up 12.4% on the three-month period, their best since the third quarter of 2021, according to BofA. The biggest winners on the month were value-oriented small caps, outperforming the broad index by 2.5%
“Small caps just emerged from their EPS recession,” Bank of America analyst Jill Carey Hall said.
The Russell 2000, comprising the smallest 2000 stocks on the Russell index, has traditionally lagged behind the S&P 500 (^GSPC) as Big Tech and other powerhouse stocks have propelled the S&P to new heights. The Russell 2000 has also always been consistently smaller, tracking above 2,490 on Monday while the S&P sat above 6,740.
But the large-cap stocks that dominate the S&P 500 have been getting increasingly expensive for investors. While the largest stocks on the market are trading at P/E ratios more than 50% higher than their historical average, Russell 2000 tickers are only trading roughly 7% higher, according to BofA, offering investors a discount.
“For the active investor, we believe there are an abundance of interesting opportunities [in small-cap markets],” Goldman Sachs Asset Management analysts wrote in a September report.
The Federal Reserve’s decision to cut rates by a quarter point after a year of no movement also proved a boon for small-cap stocks. For a group of companies — roughly 40% are unprofitable — lower rates mean cheaper financing, easier credit, and better margins, said Lou Basenese, executive vice president of market strategy at Prairie Operating Company, an investment firm focused on the US energy industry.
The index has typically done well in the first 12 months of periods when the Fed is lowering rates, BofA noted. Traders are currently pricing a 92.5% chance of another quarter-point cut from the Fed in October, which could provide another boost to small-cap stocks.
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