Since the Federal Reserve hinted at the possibility of the first interest rate cut this year, small-cap stocks in the United States have experienced an epic rebound over the past month. However, due to the uncertainty of the economic and monetary policy outlook, investors are still concerned about whether the one of the hardest-hit corners of these markets can continue to rise.

According to data from FactSet, $Russell 2000 Index (.RUT.US)$ rose 3% in the past month, while during the same period, the large-cap benchmark $S&P 500 Index (.SPX.US)$ only rose 1.4%.

Since the signal from the Federal Reserve, small-cap stocks have been volatile. The Russell 2000 index soared by about 13% in July, achieving its best monthly performance in nearly two years, but in August, it gave back nearly half of the gains. Now, market analysts believe that this bull momentum may continue.

Participants in the stock market generally have an optimistic attitude towards small-cap stocks outperforming the large-cap market in the coming months. This is mainly due to the expectation that the Federal Reserve will begin cutting interest rates on Wednesday and the possibility of the US economy achieving a so-called soft landing.

Small-cap stocks are typically more sensitive to changes in borrowing costs and economic conditions because small companies often have higher levels of debt than large companies and rely more on external financing to operate.

Valuation also seems to favor small-cap stocks, as the expected growth rate of earnings for small companies is projected to be faster than that of large companies. As of September 16th, the 12-month PE ratio for the S&P Small Cap 600 Index is estimated to be 16.7, while the PE ratio for the S&P 500 Index is estimated to be 23.4. FactSet data shows that the expected growth in earnings for small-cap index constituents in 2025 is approximately 20%, compared to an expected growth of around 15% for large-cap benchmark indices.

Matt Palazzolo, Senior Investment Analyst at Bernstein Private Wealth Management, says, "Given the valuation discount, potential profit growth, and cyclical nature of small-cap stocks, the Fed's rate cut this week is likely to serve as a catalyst for attracting investor attention to small-cap companies."

Although investors generally expect the Fed to begin easing monetary policy this week, the magnitude of the interest rate cut remains uncertain.

According to the CME Group's FedWatch Tool, as of Monday, traders in the federal funds futures market saw a 63% chance of a 50 basis point rate cut by the Fed later this week, up from about 40% on Friday. They believed there was a 37% chance of a 25 basis point rate cut.

Jonathan Krinsky, Chief Market Technician at BTIG, says that a substantial 50 basis point rate cut could further support investments in small-cap stocks. However, concerns exist that a larger rate cut could sound alarm bells, suggesting that the slowdown in the US economy is greater than expected and could undermine corporate profits and the broader financial markets.

Jordan Irving, Portfolio Manager at Glenmede Investment Management, says, "The economic conditions are the final piece of the puzzle, and investors will truly board the small-cap train when they see earning growth for the group outpacing trends, which has not yet materialized."

However, Palazzolo said that small cap investors should not get caught up in the debate between 25 basis points or 50 basis points, as this magnitude "will not have such a significant long-term impact on the economy."

He said, "Whether decision makers this week lower interest rates by 25 basis points or 50 basis points - of course this will have short-term impact on the stock market, but it will not have a meaningful impact on the difference between small caps and large caps over a significant period of time."

Jay Hatfield, CEO of Infrastructure Capital Advisors and portfolio manager of InfraCap Small Cap Income ETF, said that the recent strong performance of small caps seems to be part of the "value stocks versus growth stocks" story, which emerged when large-cap technology stocks in the so-called "Fabulous Seven" group faced resistance earlier this summer.

He pointed out that some small cap indices are heavily biased towards interest rate sensitive and dividend-paying industries, such as finance and real estate.

In the past three months, the financial sector of the S&P Small Cap 600 index has been the second best performer among the index's 11 sectors, rising 21.6%, while the real estate sector of the index rose 18.1% over the same period.

FactSet data shows that during the same period, the financial and real estate sectors were also among the best performers in the S&P 500 index.

Will the Federal Reserve cut interest rates as expected by the market in this meeting? What impact will it have on the stock market? Welcome mooer to make an appointment to watch the September FOMC interest rate meeting~

Editor/Somer