Russell 2000 Record High After Fed Cut

Small-cap stocks surged amid expectations of further easing from the Fed, as markets appear to be pricing in more risk appetite and searching for better valuations, but have pulled back slightly.

The Key Developments

• The Russell 2000 outperformed during the summer, doubling the growth rate of the S&P 500 as traders anticipated the Fed's easing.
• Small-cap stocks usually outperform when interest rates are falling and have been aided by relatively low P/E ratios, making the Russell 2000 the least stretched of the indices.
• Analysts see further upside for small-cap stocks, with some predicting that the Russell 2000 will rise at almost twice the rate of the benchmark S&P 500 over the next year.

More Upside After the Record?

The small-cap, moving from the red at the end of June to notching an all-time high in the aftermath of the Fed's rate cut last week. The index has surged ahead of its peers, growing 10% since the end of July, outperforming the S&P 500 by a factor of two. However, the performance is not entirely surprising, as small-cap stocks tend to outperform during monetary policy easing cycles. There are several reasons for that, as high leverage among smaller companies means they benefit from lower interest rates. Investors are also more willing to make speculative trades in a lower interest rate environment.

There are some particularities about the current rally in the Russell 2000, however, leading analysts to suggest. The recent rally in blue-chip stocks has been led by tech firms, which are characterised by high valuations. The over-representation in the US stock market has left market PE ratios at highs not seen since the pandemic. This makes Russell 2000 components more attractive by comparison, with a P/E ratio of 16 multiples compared to over 30X for the S&P 500. Additionally, a recent Bloomberg survey of analysts' price targets implies that the Russell 2000 has an upside of as much as 20% over the next twelve months. By comparison, the benchmark S&P 500 is projected to rise around 11% in that period using the same methodology.

Small-caps vs AI-driven Stocks

It seems that the furore around AI isn't dying out just yet, as stocks surged on Tuesday following, the owner of ChatGPT. The investment would enable the two companies to advance their AI capabilities, and OpenAI would gain access to Nvidia's new Vera Rubin platform, which is scheduled for release in the first half of next year. It would also provide OpenAI with the necessary funds to purchase additional GPUs and processors from Nvidia. The deal is emblematic of the continuing significant investment at the forefront of tech, but analysts still project that. Last month saw near-record inflows into the Russell 2000, following the Q2 earnings season, which delivered better-than-expected results. However, analysts caution that considerable uncertainty remains surrounding factors such as whether the Fed will provide as much easing as expected and the potential economic drag from tariffs.

Russell 2000 Regrouping After Profit Taking

The small-cap index has pulled back from the post-FOMC all-time highs amid a bout of profit-taking. However, this was a natural resistance level at the prior two peaks, especially as the RSI tagged the overbought territory. The index would have to overcome double-top resistance at the prior record high at 2480 before heading to the psychologically important 2500 and 2600 handles. A confirmed breakout could see prices rise as high as 2750 in the longer term. In the other direction, Russell could find support in the short term at the swing low of 2350 if last week’s low at 2400 gives way to bears.

Source: SpreadEx | US Russell 2000, Weekly chart