Small Cap Stocks are Long Overdue to Rally Higher

It may be time to buy small-cap stocks again, say analysts.

As of October 2019, the gap down in small caps brought valuations to their most attractive levels in years, noted CNBC, giving investors a long-term buy and hold opportunity. Plus, small cap stocks are less affected by global trade conditions given their domestic focus.

“Valuations have limited short-term predictive power, but matter more over the long-term,” Jill Carey Hall at Bank of America Merrill Lynch, said as quoted by CNBC. “The relative P/E today suggests that small caps should lead large caps over the next decade.”

In addition, small cap stocks also have the tendency to push higher, as the Federal Reserve cuts interest rates. In fact, small cap stocks average a one-year return of 27.9% after the Fed begins to ease, according to analysts at Jefferies. 

At the same time, larger cap stocks, average a gain of nearly 15% in that time.

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Jim Paulsen, chief investment strategist at the Leuthold Group also notes, “Small-cap tech looks like a bargain compared with large-cap peers. The S&P 600 Small-Cap Technology index trades at about half the valuation of the S&P 500 Technology index. That’s down from 0.9 times for small-cap tech in 2013, and it’s well below the 18% average premium for small-cap tech since 2003,” as quoted by ETF Trends.

Russell 2000 is Oversold, As Well

While arguments build for potential small-cap upside, we can also clearly see the Russell 2000 (RUT) is overdue to bounce higher from oversold conditions. At the moment, the RUT has been trading in a sideways consolidation pattern for most of the year. 

Should the RUT hold triple bottom support, it could bounce to the upper range of the channel.

In addition, we can see just how oversold the RUT is at its lower Bollinger Band (2,20), with over-extensions on RSI, MACD, and Williams’ %R. Each time these indicators agree with one another deep in oversold territory, the RUT typically runs higher. 

It’s just something to keep in mind if you’re thinking of jumping into small cap stocks.

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