Given the performance of mega-cap stocks like Microsoft (MSFT 1.82%) and Nvidia (NVDA 6.18%) over the past year or so, you might not be surprised to learn that much of the stock market's strong 2023 performance was fueled by larger companies, not smaller ones.
However, one analyst thinks this is about to change. He correctly predicted the stock market's sharp increase in 2023, while many of his peers were forecasting another gloomy year, and you might be surprised at what he thinks small-cap stocks will do in 2024.
One analyst says small-caps could rise 60% -- this year
In a recent CNBC interview, Fundstrat analyst Tom Lee said that small cap stocks could rise by as much as 60% in 2024. Specifically, Lee said that the Russell 2000 (benchmark small-cap index) could be above 3,000 by the end of the year, which would represent a gain of about 57% from the current level as of this writing.
This would be a major reversal from the Russell 2000's underperformance in 2023 and through the first couple weeks of 2024.
There are three specific possible catalysts Lee has mentioned that could help fuel a small cap rally in 2024:
- Money flowing into the stock market, which hasn't been the case in an uncertain, rising-rate environment as risk-free investments like Treasuries and CDs became far more appealing.
- Lower interest rates would decrease borrowing costs, and small caps are (as a group) more highly levered than large caps.
- Elevated economic growth is likely to be a big help to small cap stocks, as they tend to be more reliant on strong consumer and business spending.
According to Lee's analysis, small caps are trading for the lowest price-to-book valuation relative to the S&P 500 in a quarter-century. The last time this valuation gap was seen was 1999, and small caps outperformed the S&P 500 for the next 12 years. Previously, Lee has referred to small caps as his best investing idea for 2024.
Lee correctly predicted the 2023 stock market rally, and in fact his S&P 500 year-end prediction was the closest among all market strategists followed by Bloomberg. Most other widely followed Wall Street analysts had been calling for a rough year in 2023.
This ETF could be a great way to invest
The Russell 2000 is the most widely used benchmark index when it comes to tracking small cap stocks' performance. And while there are several excellent small-cap ETFs in the market, my favorite way to play the potential mispricing Lee is referring to is the Vanguard Russell 2000 ETF (VTWO 0.97%).
The ETF has an extremely low 0.10% expense ratio, which means that for every $1,000 you have invested, just $1 will go toward management fees and fund expenses each year.
It invests in all of the companies that make up the Russell 2000 index, so it's a broad fund without too much exposure to any one company's success or failure. The average stock in the index has a $2.3 billion market cap, and no individual stock accounts for more than 0.5% of the ETF's holdings.
In a nutshell, if small-cap stocks as a whole outperform in 2024, or over the long run, this ETF should do the same.
It's not just a short-term opportunity
First, a quick note. While Lee was indeed right about the stock market in 2023, he doesn't have a crystal ball. There's no guarantee that small caps will perform well, or that they'll outperform the S&P 500 in 2024.
Having said that, there's a clear valuation gap, and I'd argue that small caps as a whole have a lot more to gain from interest rates normalizing and from (hopefully) avoiding a recession than large caps do. Over long periods of time, small cap indices like the Russell 2000 have a solid record of returns and there's no reason to think that won't be the case in the future.
