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Russian (RU) According to Tom Lee, head of research at Fundstrat Global Advisors, the Russell 2000 index of small-cap stocks may outperform the S&P 500 by more than 100% in the next few years due to interest rate cuts and historically cheap valuations. The Vanguard Russell 2000 ETF provides exposure to small-cap stocks and has a modest expense ratio of 0.1%. While the S&P 500 has outperformed the Russell 2000 in recent years due to its higher exposure to the technology sector, Lee's prediction suggests that small-cap stocks may be poised for a comeback. Investors can consider purchasing shares of the Vanguard Russell 2000 ETF to benefit from potential outperformance.
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In general, the S&P 500 (SNPINDEX: ^GSPC) is the preferred stock market barometer for large-cap companies, while the Russell 2000 is the preferred stock market barometer for small-cap companies. Specific details are provided below:
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S&P 500: Includes 500 large-cap companies that cover about 80% of U.S. equities by market value. The median market capitalization is $37 billion.
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Russell 2000: Includes nearly 2,000 small-cap companies that cover about 5% of U.S. equities by market value. The median market capitalization is about $1 billion.
Tom Lee, head of research at Fundstrat Global Advisors, told CNBC during a recent interview that small-cap stocks may outpeform large-cap stocks by a wide margin in the near term. "I think small caps, in the next couple of years, could outperform by more than 100%," he said, citing interest rate cuts and historically cheap valuations.
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Should that prediction prove accurate, the Russell 2000 would run circles around the S&P 500 in the next few years, perhaps even doubling its return as Lee suggests. Investors can position themselves to benefit by purchasing shares of the Vanguard Russell 2000 ETF (NASDAQ: VTWO).
Read on for the important details.
Tom Lee highlighted two reasons small-cap stocks could outperform in the coming years. First, the Federal Reserve recently started cutting interest rates, and small-cap companies usually benefit from rate cuts more than large cap companies because the former usually have more floating-rate debt. Second, small-cap stocks currently have historically cheap valuations relative to large-cap stocks.
Importantly, Lee is not the only Wall Street pundit to make those points. In July, JPMorgan Chase strategist Michael Cembalest wrote, "Small-cap stocks are at their cheapest levels in the 21st century with potential market and political catalysts in their favor." The catalysts he referenced include falling interest rates, as well as the tariffs proposed by President-elect Donald Trump. Tariffs usually hurt large-cap stocks more, according to Cembalest.
Likewise, Goldman Sachs strategists Hania Schmidt and Jen Nusser addressed interest rate cuts and small-cap valuations in a recent blog headlined: Time to Shine? A Small Cap Reversal of Fortune. The key points are detailed below:
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The Russell 2000 has historically outperformed the S&P 500 by an average of 12 percentage points during the 12-month period following the end of a rate-cutting cycle.
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Since 1985, the P/E ratio of the median Russell 2000 stock has been (on average) 2% below the P/E ratio of the median S&P 500 stock. But the discrepancy is currently 28%.
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