When the market is volatile and uncertain, many stock investors generally prefer to choose the largest companies they consider to be the most stable, that is, large-cap stocks. However, in the US stock market, small stars can also shine!

Since the end of October, the US stock market has continued to reign. Among them, small-cap stocks, which have underperformed for most of this year, are shining again.

In the past month, representing stocks with a small market capitalization$Russell 2000 Index (.RUT.US)$It rose more than 4% and jumped more than 13% from the October low, outperforming$S&P 500 Index (.SPX.US)$.

As an important component of the economy, small and medium-sized enterprises contribute about 40% of the US gross domestic product (GDP), and the Russell 2000 Index is the “canary” of the economy for the market.

Craig Erlam (Craig Erlam), a senior market analyst at Oanda, said that for risky assets, a “soft landing” should be the best scenario, and investors are seeing this kind of hope.

The FOMC will combine data to determine future paths and actively communicate with the outside world, which will help avoid the risk of excessive policies, thereby reducing economic uncertainty, and facilitating sector rotation and the recovery of undervalued sectors and industries.

If the economy stabilizes or improves in 2024, the cyclical nature of the asset class of small-cap stocks may prove beneficial.

Feng Shui takes turns, is it the turn of small-cap stocks?

Why are small cap stocks popular?

For some investors, the appeal of investing in small-cap stocks is valuation. As can be seen from the chart below, judging from the ratio of corporate value to profit before interest and tax (EV/EBIT), the relative valuation of small-cap stocks and large-cap stocks excluding loss-making companies at the end of September was close to the lowest level in 25 years.

According to Bank of America Global statistics, Russell 2000's price-earnings ratio fell 12.3 times in early November, and its trading price was 19% lower than the historical average. In contrast, the price of midsize stocks was only 4% lower than the historical average, while large-cap stocks driven by the artificial intelligence boom had a 12% premium over the historical average.

Another factor supporting the continued rebound in small-cap stocks is the heightened expectation that the Fed will cut interest rates. After the last time the Federal Reserve raised interest rates in history, the Russell 2000 Index increased an average of 18.4% per year.

Furthermore, investors currently buying the S&P 500 index invest 30% of their capital in the “Big Seven” of the US stocks. If one or two of these stocks weaken and pull back, the index will risk falling sharply, which is contrary to the principle of diversification of investment. This has made small-cap stocks attract attention as a tool for diversifying exposure to giant stocks. During the tech bubble in 2000, small-cap stocks outperformed large-cap stocks, and continued to outperform the market for a long time thereafter.

How to invest in small cap stocks?

Investing in small-cap stocks, although you can tap high-quality individual stocks on your own, is more important to control the risks associated with high-growth companies. The best way to do this is to cover more small-cap stocks and target multiple industries and business sectors. Investors can choose to invest in small-cap ETFs to invest in small-cap stocks indirectly, eliminating the trouble of selecting stocks.

For example, the Russell 2000 Index is one of the most popular investment types for tracking small-cap stocks. Its ETF$iShares Russell 2000 ETF (IWM.US)$It is also one of the most popular investment targets.

Currently, the top 10 Russell 2000 ETFs hold less than 4% of the total investment portfolio, which has the advantage of diversification of investment. Of course, there are also ETFs related to the Russell 2000 Index that are leveraged, including those with 2x leverage$Proshares Trust Pshs Ultruss2000 (UWM.US)$, with 3 times leverage$Direxion Daily Small Cap Bull 3X ETF (TNA.US)$。 However, it should be noted that although leveraged ETFs can obtain excess returns, they can also magnify losses, and are not suitable for long-term holding.

Finally, in addition to ETFs related to the Russell 2000 Index, track the MSCI US Small Cap Growth Stock Index$Vanguard Small-Cap Growth ETF (VBK.US)$It's also an appropriate choice, but investors should also comprehensively consider various information such as liquidity and fees when choosing such ETFs. Here are the top ten large cap ETFs selected by VettaFi based on capital size for your reference:

It is important to note that small-cap stocks tend to have higher volatility. The annualized volatility for the past five years has reached 24.6%, far higher than the 19.5% volatility of the Russell 1000 Index. In addition, there are many unprofitable companies in small-cap stocks. According to a report released by Apollo Global Management in mid-November, about 40% of the Russell 2000 index constituent stock companies are in a losing state.

Mabrouk Chetouane, head of global market strategy at Natixis IM, believes that the decline in trading volume at the end of the year and the insistence of major central banks that it is still too early to consider cutting interest rates have caused small-cap stock investment to face unknown risks. If there is a negative impact, market segments with less liquidity will be more volatile.

Editor/Corrine