$Russell 2000 Index (.RUT.US)$In just five days, the stock market rose by 12%, reaching a new high in 2024. After an unprecedented rebound in the past week, can the small-cap stock market sustain its momentum? Is it a rebound or a reversal?

Last night,$NVIDIA (NVDA.US)$leading a group of AI giants suddenly fell, Nvidia plummeted by 6%, and other giants also fell in succession. It is worth noting that as the stock market experiences a semi-sell-off, investors have recently shifted from large-cap stocks to small-cap stocks. This rotation began last week when the latest inflation data made investors more optimistic about the Federal Reserve's interest rate cuts starting in September. On Wednesday, the small-cap stock index fell by about 1%, and the technology stocks-based stocks fell nearly 3%.$ASML Holding (ASML.US)$,$Taiwan Semiconductor (TSM.US)$Several Wall Street investors have also expressed bullish views on small-cap stocks. Earlier, Thomas Lee, one of the most optimistic market analysts on Wall Street and co-founder and research director of FundStrat Global Advisors, firmly believed that the Russell 2000 Index, which tracks small-cap stocks, will rise 50% this year. Lee's bullish outlook on the index includes lower interest rates, stock prices of constituent stocks far below the S&P 500 and Nasdaq 100 constituent stocks, and a large amount of cash in the money market waiting to be invested.$NASDAQ 100 Index (.NDX.US)$The Russell 2000 Index has outperformed the large-cap stocks in the Nasdaq 100 index for five consecutive trading days. The SPDR S&P Small Cap Information Technology ETF ($562560.SH) has risen 8.5% since last Tuesday, while the Nasdaq 100 index has fallen 0.3%. According to the morning briefing from DataTrek, the small-cap information technology index (PSCT) is worth paying attention to.

Bullish sentiment for small-cap stocks is at an unprecedented high.

Options positions prove that the current market sentiment toward small-cap stocks is bullish. According to Mandy Xu, director of derivatives market intelligence at the Chicago Board Options Exchange (Cboe Global Markets), over the past few trading days, demand for call options related to the Russell 2000 index and exchange-traded funds (ETFs) tracking the index has surged, driving up the premium trading for these contracts over put options.

Market data from the Dow Jones shows that last Thursday, trading volume for call options related to the Russell 2000 index and iShares Russell 2000 ETF reached its highest level in years.

She proposed five stocks worth following in this sector, namely Fabrinet (FN.US), SPS Commerce (SPSC.US), Insight Enterprises (NSIT.US), Nvidia, and Badger Meter (BMI.US).$S&P 500 Index (.SPX.US)$"As yields fall, small-cap stocks with long-term orientation towards growth and more sensitive to changes in capital costs are relatively benefited, while small-cap stocks that are more sensitive to the economy (i.e. value) are not," she said during a conference call.

Important bullish signal: Q3 earnings growth expected to exceed the 'Magnificent Seven'?

It is worth mentioning that some analysts predict that profits for small-cap stocks will increase by 27% this quarter, and 67% next quarter, significantly faster than the expected growth of heavyweight companies.

Not long ago, Morgan Stanley's US equity strategist recommended that as the Fed may cut interest rates, investors should consider investing in small-cap growth stocks. Katy Huberty, the bank's global research director, said in a report on Tuesday that the strategists' 'subtle relative judgments' on US small-cap stocks suggest they are more inclined to increase holdings of growth stocks rather than value stocks.

Huberty said during a conference call, "As yields decline, small-cap growth stocks with a long-term outlook that are more sensitive to changes in the cost of capital are relatively beneficial, while small-cap stocks that are more sensitive to the economy (i.e., value stocks) are not."$Microsoft (MSFT.US)$During the phone conference, it was stated that "with the decrease in yield, small-cap stocks with a long-term growth orientation and greater sensitivity to changes in capital costs will benefit relatively, while small-cap stocks that are more sensitive to the economy (i.e. value) will not benefit."

Morgan Stanley strategists said that due to earnings corrections, there is greater relative upside for small-cap growth stocks. Huberty also said that history has shown that when the Fed begins cutting interest rates, performance of growth small-cap stocks usually outperforms.

In addition, biotech stocks are potential winners because they have the largest weightings in the Russell 2000 small-cap stock index. She said that biotech 'has a strong history of relative performance post Fed rate cuts.'

Analysts name 5 'tech small-cap stocks'

The Russell 2000 index has outperformed the large-cap stocks of the Nasdaq 100 index for five consecutive trading days. S&P Small Cap.$ChinaAMC CSI All Share Information Technology ETF (562560.SH)$According to the morning briefing from DataTrek, the small-cap information technology index (PSCT) is worth paying attention to.

Looking at the relative returns of the small-cap technology stock (PSCT) and the Nasdaq 100 index (QQQM) over the past year, since 2014, small-cap technology stocks have lagged behind the Nasdaq 100 index by 4.3 percentage points in any given year, with a standard deviation of 16.2 percentage points. In addition, the rolling annual return of small-cap technology stocks has lagged behind the Nasdaq 100 index by 38.8 percentage points recently, more than 2 standard deviations below the long-term average.

Jessica Rabe, co-founder of DataTrek, wrote: "The only other time small-cap tech underperformed this badly was in H2 2020 as US stocks rebounded from the short-lived bear market driven by the pandemic earlier that year. And of course, that rally was led by large-cap technology stocks (XLK) rather than small-caps."

Despite a rebound last week, small-cap technology stocks are still underperforming the Nasdaq 100 index by 26.7 points year-to-date. This is more than 1 standard deviation, so it is still in an unusual area.

According to the report, from 2014 to 2019 (a period when the market was more 'normal'), small-cap tech stocks underperformed the Nasdaq 100 index by 1.5 percentage points in any given 1-year rolling period, with a standard deviation of 10.8 points, resulting in downward levels of 1, 2, and 3 standard deviations of -12.3, -23.0, and -33.8 points, respectively.

Small-cap technology stocks have recently underperformed the Nasdaq 100 index by 3 standard deviations. Prior to 2020, its performance had never lagged behind the Nasdaq 100 index by 3 standard deviations.

After 2019, small-cap technology companies underperformed the Nasdaq 100 index by 3.7 points in the following year, with a winning rate of 37%; when underperformance was 2 standard deviations, the underperformance was 0.9 points, with a winning rate of 68%.

"Post-2020 history shows that for small-cap tech to outperform the broader market, either there needs to be a speculative tech bubble or 'large tech' needs to fall out of favor," Rabe said.

"The sector may have momentum to outperform the broader market in the short term, with other opportunities hidden in more industrial and niche markets," Rabe said.

She proposed five stocks worth following in this sector, namely Fabrinet (FN.US), SPS Commerce (SPSC.US), Insight Enterprises (NSIT.US), Nvidia, and Badger Meter (BMI.US).$Fabrinet (FN.US)$,$SPS Commerce (SPSC.US)$,$Marathon Digital (MARA.US)$,$Insight Enterprises (NSIT.US)$Nvidia$Badger Meter (BMI.US)$.

Edited by Jeffrey